Global Equity Shariah Monthly Report | January

• AMAL will invest in companies of a high quality with wide economic moats.
• Our Shariah ETF will take active positions against the MSCI World Index (the index) with typically 30 positions against the index’s 400 constituents
• Historically, Sanlam Investments has managed to outperform indices through a rigorous valuation process that selects high quality businesses.

Performance Review

Monthly Performance of Fund/Sector

• In December, the Shariah ETF's net asset value increased by 2.5% in Dollar terms.  We saw strong performances from some of our names including Samsung, Taylor Wimpey, and EssilorLuxottica.  Alibaba and Sanofi were our bottom performers during the month.
• Investors appear to be looking beyond the short–term noise of political unrest and the sustained pressure of the virus, towards a rosier medium-term outlook of vaccine roll-outs allowing lockdowns to end and economies to reopen.

What Has Driven This Performance?

The best performing stock this month was Samsung (+20.5%). The company continues to profit from stay-at-home behaviours which have fuelled demand for their DRAM and NAND memory chips. These chips are used in tablets, smartphones and data centres, which have all seen a sharp increase in usage as a result of the pandemic. Their semiconductor business remains the company’s primary profits driver. We would expect the emergence of 5G technology to drive future growth as more data is required to service newer applications. Digitalization in non-IT industries will also drive a growth in data traffic.  Taylor Wimpey continued to post strong returns of 10.3% during the month, amounting to a more than 60% USD return over the last quarter of 2020.   

In terms of laggards, Alibaba (-11.6%) under performed during the month. Alibaba continues to suffer at the hands of the regulator as the government announced an anti-trust investigation into Alibaba’s relationship with its suppliers. This heavy-handedness looks, at least in part, a result of the critical comments from Alibaba founder Jack Ma about Chinese regulators. We still believe that the growth drivers of the company remain intact.

Source of all data: Sanlam Investments. Past performance is no guarantee of future performance.   

Portfolio Activity

We have been reducing our Samsung position in the fund in December after a strong rally in the last quarter of the year.  Samsung has been a position in the fund since fund launch and the stock has rallied 44%, significantly outperforming the market over the quarter.

Fundamentally we use a discounted cash flow analysis to determine fair values for the companies we invested in.  Samsung is a good example of a high quality business which was hugely out of favour for some time over the last 3 years, yet we have always believed this is a high quality company trading at very attractive levels.

We use very conservative assumptions in our cash flow analysis of Samsung due to the cyclical nature of some of the industries it operates in.  Even though the valuation is not excessive in isolation based on 1) historic multiples of free cash flow and 2) other valuation measures, the stock is now trading above fair value.  We have reduced our position size aggressively while deploying capital in other opportunities.

We added to our positions in Roche and Novartis on weakness in early December. We believe that these companies offer attractive total return prospects.

Taking Novartis as an example:

• We calculate the company will generate an average 17bn Swiss Francs of annual free cash flow over the next 10 years.
• This translates into 8.5% annual free cash flow yield based on existing enterprise value.
• Over the next decade the company’s revenues should not be exposed to cyclical headwinds even though product risks remain.
• A high free cash flow yield is very attractive in a low return environment against low equity market expectations

We sold our position in EssilorLuxottica.  The stock was our third best performer this month after a 10% rally in December and a 17% rally in the last quarter but the stock is now trading above fair value.  The market has taken a lot of positives from EssilorLuxottica over the last quarter.  At the end of September, more than 95% of the Company's stores had reopened.   Furthermore, Ecommerce sales were up 40% in the first 9 months of the year. The company’s end markets in developed market returned to year on year organic growth in the 3rd quarter.  Emerging markets improved significantly in the last 6 months as well.

Fundamentally the company remains on track to deliver cumulative synergies of Eur420-600m by 2023.

We like the eye-care and eye-wear industry for its long term growth prospects, especially in Asia, but we would like the stock to pull back before revisiting.

We sold our position in Corteva after a 35% rally since fund launch.  Our original thesis when we invested in Corteva played out very quickly.  Corteva was spun out of DowDuPont in June 2019. The company is now an independent grower of seeds and manufacturer of crop protection chemicals for those seeds.  The company distributes its products to farmers around the world. Corteva is the second largest AgriScience company after Bayer.

Our bullish case was based on Corteva is establishing itself as independent company by optimising its cost base and launching class leading products. The high cost base is a result of carrying stranded costs from both Dow and DuPont after their merger; management has already made good progress here and there is more to go. The company is in an early phase of product launches which means we will see increased sales and lower costs due to lower licensing revenue being paid to competitors. The combination of these factors should result in the company creating value for shareholders.  We would like to engage with this name again but at a more favourable entry point.

We have been adding to our position in Alibaba which is now our biggest position in the fund.  Alibaba sold off sharply following reports that the Chinese government will open antitrust investigations against it.  Founder Jack Ma's careless critique of China’s financial regulatory body may have led to this investigation.  We are hopeful that China will not go too far in curbing the growth of Alibaba.  We see significant opportunity for Alibaba to drive strong growth in ecommerce, payments and cloud computing.  The future is always uncertain but the company’s ability to grow free cash flow should be intact.  We will continue to monitor the company’s strategic direction as the Chinese regulator clarify its position in more detail.  

Source of all data: Sanlam Investments. Past performance is no guarantee of future performance.

Outlook

A new year dawns with a heightened need for a fresh start. With 2020 now firmly behind us, we can approach this year with renewed hope and a desire to seek new and exciting opportunities. Caution will need to be exercised, but there is much to feel positive about.  It would be naive to suggest that the effects of the global pandemic are in the past. But with a portfolio of vaccines on the horizon, there is light at the end of the tunnel, and from an investor’s perspective that means a return to economic growth and business opportunity.

The strong recovery of global equity markets form the lows in March led to extreme differences between regional and sector performances during 2020.  A strong rally in risk assets benefited the fund during the last two months of the year as global equity markets rallied by 17.5% in US$ from the end of October.  The rally was the result of good news on a vaccine for COVID19 in early November. With interest rates at near zero levels in most Developed Markets, it proved to be the additional catalyst that lead the market to look through any short term weakness and the return to a more normal world. The strength carried on into December and until year end.   

The market was also buoyed during the latter quarter by the victory of Joe Biden in the US presidential election. The Democratic Party is promising new large amounts of fiscal spending and will hopefully also bring about better diplomatic relations globally. The additional surge in markets in the last quarter was led by the sectors that had lagged for many years now.  The energy sector in particular proved evidence of a dramatic reversal, returning over 29% over the last quarter, along with materials and industrials which also posted strong returns.  This was not however, enough to lift the energy sector from the doldrums of earlier in the year as it still lost over 30% over the course of 2020.  Our stocks performed well in absolute terms however it was difficult to keep up with the market with the above mentioned sectors performing so strongly, as they are ones our philosophy tends to avoid based on quality metrics.

Global equity markets finished the year up 16% in US$.  The US contributed 12% of the 16% returns in 2020 or 75% of global equity market returns.  The technology heavy NASDAQ index ended up close to 50% for the year driving global equity markets higher.  The UK was the biggest drag on global equity markets as Brexit worries persisted.  Continental European equity markets were clear laggards this year (+6%) yet Japan was surprisingly strong returning more than 15% in US$.  We maintain our Japanese exposure through Kao, with the Japanese market representing 1/12th of the world’s market capitalisation.  Emerging markets finished up 18% in US$ for the year and benefited investments like Samsung which posted strong returns in 2020.  In Europe we invested in new names like SAP, and Novartis when valuations became very compelling.  We have carefully analysed these businesses and were patient for our chance to invest and add to our positions.  One should note though that our decision to invest in these names was not based on a view that “Europe is cheap” but purely on bottom up analysis of these multinational businesses.

The concentration risk in global equity markets has reached new levels as a few names dominate short term returns.  This becomes particularly prevalent when looking at a Shariah compliant universe where a number of companies are already excluded based on Shariah principles.  We aim to invest in high quality companies but only when the valuations are attractive.  It is important for us to invest with a long term objective of holding on to superior businesses.  Companies like Johnson & Johnson, Medtronic and Roche have featured in our long term high quality strategy for more than 5 years, and in some cases longer. 

Investing in new high quality businesses like Novartis, Alibaba, and SAP for example in 2020 protect the fund against concentration risk whilst maintaining exposure to long term secular growth industries.  We view industries like healthcare, and ecommerce as secular growth opportunities which will outperform other slower growth industries or ones in terminal decline.  Valuation discipline is imperative at this stage in a market cycle and we continue to adopt this discipline. There are always selective opportunities for the patient investor as some sectors of the market have participated in the bull market to a much lesser extent than others.

We continue to rotate the portfolio into areas of the market where we see longer term value and we trim areas that have been constructive for a long time but we assess that these names have now become excessively valued. We would love to own many of these businesses forever but we are not prepared to pay any sort of valuation to achieve that.

We have shifted out of stocks with excessively high valuations into stocks with more realistic valuations.   Investing in the likes of Novartis, Johnson & Johnson, Alibaba, SAP and Samsung are testament to our adherence to:

• Investing in high quality businesses                     
• Maintaining valuation discipline by not overpaying                      
• Hold on to these businesses with preferably a multiyear time horizon

As a consequence of our actions our portfolio has retained its attractive valuation.  Shiseido and EssilorLuxottica are excellent businesses but they are expensive hence our decision to sell them.  Most “pure growth” portfolios have become more expensive during the pandemic.  This may be unsustainable for investors only focused on growth and not adhering to valuation discipline but only time will tell if valuation still matters.

Source of all data: Sanlam Investments. Past performance is no guarantee of future performance.

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