Coronation - Senate Group Nov 2015

transcript

Market update and current views

Presentation to The Senate GroupPeter KempenNovember 2015

Coronation’s positioning

Markets have bifurcated• JSE: R100 invested in

� RESI 3 years ago now worth R82� FINDI 3 years ago now R182

• Global Equities: USD100 invested in � MSCI World 5 years ago is now worth $163� MSCI GEM 5 years ago is now worth $91

The big miners have been carried out• Rand share price declines between 58.1% (Glencore) and 98.5% (Lonmin) since peak

Rampant USD, especially against EM & commodity currencies• Our GEM fund lost 20% over the past 12 months on BRL & RUB currency movement alone

Our performance• SA Multi-asset

� Comfortably first quartile 3 years plus, around average shorter periods• SA Equity

� Comfortably above average 2 years plus, behind average shorter periods because roughly 20% in miners� Top 20 < Equity by ±3% p.a. given difference in concentration levels

• Global� Opps Equity FoF above average all periods� Directly managed funds lagging shorter term because of ± 30% of equity in EM

Performance

Source: Morningstar as at 30 September 2015

-30.00

-20.00

-10.00

1 Year 3 Year 5 Year 10 Year

Rate of Return (%)

ASISA SA Equity General

Coronation Top 20 A Coronation Equity R ALSI Top 40

Performance

-30.00

-20.00

-10.00

1 Year 3 Year 5 Year 10 Year

Rate of Return (%)

ASISA MA High Equity Sector

Coronation Balanced Plus A Balanced Plus Composite Index

Performance

1 Year 3 Year 5 Year

Rate of Return (%)

ASISA SA MA Low Equity

Coronation Balanced Defensive A STeFI 3m + 3%

Coronation Houseview Equity Fund - 1 year rolling al pha

Short-term alpha is lumpyA successful track record comes with testing years

Selling inflated rand-hedge stocks

Buying depressed interest rate sensitive stocks

As at 30 September 2015

Selling overvalued commodity and construction shares

Selling inflated domestic stocks &

buying cheap global JSE listed stocks

Selling overvalued defensive domestics & buying depressed commodity stocks

Alpha over meaningful periodsIt’s over the long term that we measure results

As at 30 September 2015

Coronation Houseview Equity Fund - long term alpha

5 year alpha 10 year alpha

Domestic Equity Funds

Source: Morningstar, Coronation Research as at August 2015.Based on rolling 5 year return (as at month end) calculated over the past 10 years.

0% 25% 50% 75% 100%

Coronation Equity R

SIM General Equity R

Prudential Equity A

Coronation Top 20 A

Foord Equity R

Prudential Dividend Maximiser A

PSG Equity A

Allan Gray Equity A

STANLIB Equity R

Investec Value R

Investec Equity R

Nedgroup Inv Rainmaker A

1st Quartile 2nd Quartile 3rd Quartile 4th Quartile

Multi Asset High Equity Funds

Source: Morningstar, Coronation Research as at August 2015.Based on rolling 5 year return (as at month end) calculated over the past 10 years.

0% 25% 50% 75% 100%

Coronation Balanced Plus A

Foord Balanced R

Rezco Value Trend A

Allan Gray Balanced A

Investec Opportunity R

Prudential Balanced A

PSG Balanced A

STANLIB Balanced B1

SIM Balanced R

Nedgroup Inv Managed R

Investec Managed R

1st Quartile 2nd Quartile 3rd Quartile 4th Quartile

Global macro economic environment

US the only major economy ready to start hiking interest rates • Although we do not expect a sharp cycle the improving economy no longer warrants zero interest rates

• The big medium term (historical) reason for EM falling out of favour… remember the taper tantrum?

Chinese stock market volatility must not be seen as a predictor of the economy • But the economy has slowed and a hard landing remains the greatest global macro worry

• Fears about China is the proximate cause for August’s return of volatility

• Policy has become more stimulatory as the economic slowdown continues

Greece got to the edge of the cliff but not quite over it• Caused initial spike in volatility and eventual Grexit remains a possibility

• No-one cares for now as the can has been kicked down the road

� Expect to hear about Greece again in 2017…

• Deflation still the ECB’s major focus... no interest rate hikes on the horizon here

Commodity prices fall further• Commodity producer currencies very weak

Unsynchronized growth

US: Recovery in employment means rates will start rising

Source: I-net

China slowing more

China: more evidence of slowdown

Tumbling commodities

Source: I-net

GEM currencies very weak vs. USD

CNY devaluation in context - Other EM & Commodity currencies hammered

Future of emerging markets

EMs are caught in a macro driven storm

• Concerns over Chinese growth combined with Fed hike expectations and a strong USD

• There has been a collapse in EM since the Chinese stock market started declining with an acceleration since the renminbi was devalued by ±3%

• Many commodities and EM currencies are at levels not seen since the ‘90’s

• Capital outflows from EM are now being compared to those of the GFC

Surge in EM outflows hits share prices and currencies

…yet life continues to go on for the companies in wh ich we invest, their long term prospects are attractive and valuations are ve ry low

Not a fair illustration of the opportunities available in emerging markets

MSCI GEM Index

Large MSCI GEM index holdings mostly are/have:• Below average businesses – banks, energy, tech hardware

• Significant state ownership / state regulation

• Poor stewards of capital

• Cyclical earnings

An investment in these companies does NOT represent the opportunity set in EM

If you invest in poor businesses, expect poor long term returns

Right now:• Global macroeconomic environment is uncertain and looks especially poor in EMs

• Expect volatility to continue but in EMs you can find…

• Great businesses� At attractive valuations� With powerful long term structural drivers� That make great long term investments� And can’t be captured in the DM space

Think beyond the index

Russian Food Retail: the long-term opportunity

Top 5 grocery retailers in Russia are 20% of market (vs. 60-70% in established

markets)

Where else can you get growth like this?• Exceptional businesses

• Great management teams

• Experienced crises like this before and thrived

• At attractive valuations

Russia Food Retail

368 6101 014

1 5001 893 2 194

2 5683 204

10 000

12 500

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 F2015

Magnit Convenience Store Base

Brazilian Private Education – why invest?

Government target not very aggressive

33% target

DL centres exclusively private sector run

Private sector has taken 90% of new campus

students over this period

Powerful incentive to study further given uptick in

lifetime earning potential

Tertiary education almost non-existent outside the wealthy

Loan growth 1.3 – 3.0x nominal GDP for close to 20 years now• But still under-banked by most metrics

Indian Banks

Mortgages and retail loans still very small in the mix

Indian Banks

Public sector banks losing market share to private sector

Indian Banks

Several businesses in many industries rapidly capturing the market

Large investible universe spread across:• Search

• eCommerce

• Online travel

• Mobile Value Added Services

• Gaming

• Video

• Classified advertising

• Recruitment

• Property

• General portals

China Internet Stocks

Online shopping already larger than USA and still growing fast

China Internet Stocks – JD.com / Alibaba

The “Google” of China

China Internet Stocks - Baidu

250 000

500 000

750 000

1 000 000

1 250 000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Baidu - number of advertisers

It is normal to second guess allocation to an asset class when it has underperformed so significantly BUT

A long term specific allocation to GEM is still appropriate

Global equity managers are generally structurally underweight GEM• Where global managers do invest in GEM it tends to be a narrow universe of the biggest, most liquid

names in the asset class

Industry structural drivers that are common in GEM are simply not present in DM

All asset class returns may be lower going forward

Cannot afford to miss out on long term return opportunities where they are available

Why invest directly in GEM?

GEM Fund upside (weighted average) and PE

112.5%

Ave P/E (left)Ave Upside (right)

GEM share of world GDP is up from 35% in 1993 to 50% today

FX reserves in EM were half of DM in 2000, they are now double that of DM

There has been (and will continue to be) improvement in economic situations

• E.g. Brazil Debt/GDP is half what it was in 2002

Foreign direct investment into GEM has increased 10 fold from 2005 to 2014

• This is 30% faster than in DM

While EM companies represented 5% of the Fortune Global 500 from 1980 to 2000, they are now 26%

Set backs currently experienced resulting from rising US rates, shrinking commodity demand and a slowing global economy are normal and have been witnessed in most economies over time

GEM has survived two massive crises in the recent past: Asian crisis of 1998 and the GFC of 2008 and come out of each stronger

GEM will learn from this crisis and emerge stronger, and increasingly relevant

GEM will remain relevant

Source - http://foreignpolicy.com/2015/08/31/what-future-for-emerging-markets/

SA vs. GEM• GEM is a very different investment set from SA

• SA has also provided great long term returns despite volatility

DM vs. EM valuations• Upside to fair value on most stocks in our GEM coverage list far exceeds that in DM

“Hot money” is fleeing EMs• These investors were never making long term allocations

• “Smart money” should not be influenced by the actions of “quick money”

Market performance vs. economic performance & company performance• Dislocation between company performance and macroeconomic environment

• Recessions are often good for businesses over the long term� Weaker players exit => reduces excess capacity� Market share increases for the remainder

• Stock markets move out of sync with economic performance� Don’t disinvest when (macro) times are tough� Don’t invest only when times are good� A long term, through the cycle allocation is appropriate� Size of allocation depends on valuations, which are very attractive today

Some final points to consider

SA macro concerns

Low commodity prices and sluggish growth in trading partners undermining exports

Reserve Bank intent on normalizing interest rates but in the weak economy a very mild cycle anticipated

Lower oil has taken some pressure off inflation

Combination of rising interest rates and a sluggish economy not good for already highly rated domestic equities

Global environment a headwind, but we have added to our woes by scoring own goals:

• Eskom – big blow to confidence and growth

• The visa debacle

• Poor fiscal discipline

• Corruption and wasteful spending at SOE’s

Downward commodity cycle and own goals

The visa debacle

Undisciplined government spending

Source: Prescient Securities(data from WEO database and the NT Budget Review)

Sorry saga at the SOE’s

SA equities

Our exposure to domestic equities is low across all balanced funds on valuation grounds

Massive divergence continues• Resources has sold off dramatically

• Bid for SAB at very high multiple

Corporate action in the platinum sector encouraging

Banks relatively attractive

More SA companies looking to expand off-shore• Mediclinic, Truworths, Foschini, Brait, Woolworths, Steinhoff among the more recent movers

JSE listed global stocks such as Naspers, Richemont, MTN, Steinhoff and British American Tobacco continues to offer the SA investor much needed geographic diversification and offers reasonable value

SA Equities

ALSI surprisingly resilient

Source: I-net

But resources hammered

Source: I-net

Company30-Jun-08 31-Jul-15 Price

movePrice Price

Anglo American 548.00 159.87 -71%

Exxaro 144.45 74.91 -48%

Impala 309.00 45.51 -85%

SAB 178.05 661.48 272%

Truworths 22.95 85.55 273%

Bidvest 98.38 307.90 213%

AVI 12.95 79.80 516%

Mr Price 15.00 252.20 1581%

Spar 49.50 197.87 300%

Relative performanceResources versus industrials

Source: I-Net

Relative performanceResources vs. FINDI

Source: I-Net

Commodities & the miners

JSE classification shows basic materials as 28% in Top 20 and 23% in Equity

9% / 6% is Mondi which is anything but a typical resource company

19% / 17% in ‘traditional’ resource companies

On a look through basis roughly half of this is SA based mines and the rest is outside of SA

Predominantly exposed to diversified miners and Platinum

Lower risk commodities with less ‘China’ risk

Exposure to the miners

Setting the sceneSupercycle and aftermath

Up 900%

Source: I-Net Bridge

Chinese consumption of raw materials

Source: www.visualcapitalist.com

The current outlook for commodity demand is weak across the board• Weakness in China, the major engine of demand growth

• Rest of the world struggling too

• Longer term threats of electric vehicles and renewable energy gaining traction

Most commodities are in oversupply (still growing or not closing quickly enough)• Barriers to exit is likely to keep supply in the market for longer than expected

• Last supercycle projects still being delivered

• Governments often support loss-making industries to protect jobs

Earnings have already collapsed and at spot prices most commodity companies are under increasing pressure and earnings and cash flows will be low

Despite this, we believe the valuations of the mining companies are attractive enough to warrant a reasonable position in our funds

• We prefer commodities where supply growth will be more muted in the long-term� Platinum, copper, diamonds

• We prefer companies with high quality, low cost, long life assets� Impala and Northam� Anglo American� Sasol

Resources sector view

Earnings are low and heading lower

Price-to-earnings ratios

Historic Spot Normal

I-net Coronation estimate Coronation estimate

Anglo American 51.1 1427 5.3

Exxaro 6.7 9.2 5.2

Impala 115.4 Neg 3.1

BHP Billiton 15.6 34.9 11.9

Glencore 21.3 137 4.4

Northam -15.4 Neg 3.8

Amplats 22.6 Neg 6.0

Sasol 8.7 11.2 8.2

… but long-term valuation looks compelling

Returns and valuations at multi decade lows

From already low levels we have seen further severe weakness

Since June Rand basket down 15%

Significant implications for miners

Collapse in PGM prices

Source: I-net

45% of industry production unable to cover cash costs

70% of industry production unable to cover cash costs + sustaining capex

Only mines viable at these prices are

• Amplat’s open pit Mogalakwena (needs more capex)

• Zimbabwe – comes with its own specific set of challenges (ownership, taxes) etc.

Logical response: cut loss making production

Seen some of this already:

• Amplats: 400k oz. at Rustenburg and Union

• Lonmin: 100k oz.

Barriers to exit in the industry are high:

• Reducing labour incredibly difficult

• Overheads spread over a smaller production base � increasing unit costs

Consequences are severe

General commodity sell-off

Concerns about areas of China slowdown specific to PGMs

• Platinum: jewellery demand

• Palladium: auto sales

Anti-diesel lobby in Europe

Concerns about growth in recycling

Concerns about changes in drivetrain technology:

• Battery electric vehicles

Concerns about changes in vehicle ownership patterns and replacement cycle:

• UBER

• Ride-sharing

What is causing the rout?

SA and Zimbabwe have 55% of global supply of PGMs

Autocats absorb 45% of Platinum and 80% of Palladium... tightening emission controls a positive

30% of Platinum goes into jewellery

• Predominantly China where increasing wealth levels and rise of middle income consumer are long term drivers

PGMs less dependent on China than most base metals

PGMs have some attractive fundamental drivers

Trading on PE’s of 5-6x normal earnings

Trading at discount to replacement cost:• Cost to build 1 vertical shaft + concentrator on Western Bushveld: R11 - R13bn

• The majors operate many shaft complexes

• Yet trade at market caps way below the cost to replicate their infrastructure:� Lonmin: R3bn� Northam: R17bn� Implats: R30bn

Compelling valuation

Bonds • Excessively low and even negative bond yields for low risk sovereigns offer no value

• Domestic bonds offer relatively far better value

• Corporate debt preferred to government debt

Equities• Global (fairly valued) preferred to domestic (expensive)

• Within global equities EM’s certainly cheaper but with clearly higher risk

Property• On a bottom-up view we find some value in selected counters but in general the very low bond yields

have pushed global property yields too low

• Domestic property has likewise run hard but in a low yield world and relative to very pricey equities offers reasonable value

Current asset allocation view

Return expectations

Expected asset class returns

as at 31 July 2015

Last 10 years (ZAR)

10 year forecast (ZAR)

Local equity 17.2% 7 – 10%

Global equity 14.1% 10 – 13%

Local property 20.4% 7 - 10%

Local bonds 8.2% 6 – 9%

Global bonds 10.5% 5 - 7%

Cash 7.5% 6 – 8%

Inflation 6.2% 6% +

Asset allocation is the most important decision you make in investments

Above table shows importance of alpha generation in achieving targeted return

Big difference between rear-view

mirror and windscreen

Alpha much more valuable in lower return environment

Increase in purchasing power over n years at different real return rates

“The greatest shortcoming of the human race is our inability to understand the exponential function”

- Albert A. Bartlett

Real return: 0.5% 1.5% 2.5% 3.5% 4.5% 10%

n = 10 years 0.05 X 0.15 X 0.26 X 0.38 X 0.52 X 1.46 X

n = 30 years 0.15 X 0.52 X 1.01 X 1.65 X 2.48 X 13.95 X

Outlook and conclusion

Commodities near the end of the down cycle as evidenced by many loss making producers

GEM currencies (tougher to call) have experienced a big cycle already• There could be even more pain, but its difficult to argue the pain has just started

Developed world stocks trade around fair value

GEM stock markets have had a deep down cycle, now offering far more upside than downside

SA stock market has held up quite well. Many high quality stocks trading at very high multiples in a low growth economy. Downside risk not to be ignored

The lower return world we have warned about repeatedly is here

Most upside can be found in bombed out cyclical sectors, but uncertainty around global and domestic growth limits our appetite for these stocks

Investment outlookWhere are we in the cycle?

Sticking to our knitting…

“Investment risk resides most where it is least perceived, and vice versa. When

everyone believes something is risky, the unwillingness to buy usually reduces its price to the point where it is not risky at

all. Broadly negative opinion can make it the least risky thing, since all optimism has been driven from the price… When everyone believes something embodies no risk, they usually bid it up to the point where it’s enormously risky. As no risk is

feared, no reward for risk bearing is demanded or provided. That can make

the thing that is most esteemed the riskiest”

- Howard Marks, Oaktree

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information given. It is therefore recommended that the potential investor/client first obtain the appropriate legal, tax, investment or other professional

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past performance is not necessarily a guide to future performance. Coronation Fund Managers Ltd is a full member of the Association for Savings and

Investment SA (ASISA). Coronation Asset Management (Pty) Ltd is an authorised financial services provider (FSP 548).

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Coronation - Senate Group Nov 2015

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