Index-tracking investment in South Africa: What to consider in 2021

Investors are heading into this year with 2020 whiplash and wondering what they can do to find returns in the current market.

Satrix – South Africa’s 20-year-old index investment group – says that off the back of a good last quarter of 2020, investors would do well to keep a few key insights into the investment landscape in mind for 2021.

Kingsley Williams, chief investment officer at Satrix, said that, after a whirlwind 2020 kept throwing surprise after surprise at the world, it is no wonder that markets were turbulent.

“However, the news has not all been bad. While it took almost two years to recover from the 40% drawdowns experienced in 2009 with the global financial crisis, it took just eight months to bounce back from the sharp losses experienced in March of 2020.”

Satrix saw its assets under management grow by 20% in 2020. It now manages R120 billion in assets investing in 45 markets globally. “In arguably the most challenging market conditions of our lifetime, we saw strong flows into affordable and robust index-based investments, such as ETFs,” said Williams.

Speaking at a recent ‘Index investing through a pandemic’ webinar, Williams shared insights from Satrix regarding the 2021 investment outlook:


Capped SWIX represents the most value

“While the ALSI and CAPI give higher weight to dual-listed companies like Anglo, BHP & Richemont, which derive significant portions of their earnings from offshore, Capped SWIX is more of an ‘SA Inc.’ play, with the highest exposure to local earning sources.

Given the lacklustre growth we’ve had from our local economy, it’s no surprise that Capped SWIX has lagged recently relative to the other three.

“Capped SWIX represents the most value; it’s the cheapest index with the lowest PE ratio and the highest dividend yield. We like Capped SWIX because it’s the most diversified index of them all; it provides a lot more freedom to express your views because it is so well-diversified,” said Williams.


Resources and financials sectors are ones to watch

While industrials have been the standout performer, due to the ‘Naspers effect’, resources and financials are the ones to watch going forward.

“Historically, financials mimicked the performance of our headline indices, but they significantly underperformed in 2020, with some bounce back in the last quarter. We’ve seen much recovery in this sector, which remains highly regarded globally. This underperformance should be a short-term blip.”


Factors: drivers of excess return

“Our research has shown factors have the power to explain a significant portion of excess returns available in our market,” Williams said.

He said it’s interesting to see how different factor strategies performed over the year. “If you remember, dividends started to be cut once we went into lockdown.

“Companies began to conserve cash reserves, which significantly impacted the FTSE/JSE Dividend+ Index, causing it to significantly underperform as markets started to recover. However, as interest rates were cut, the hunt for yield started to play out, and investors began returning to high yielding strategies.”

The FTSE/JSE Dividend+ Index ended up being the top-performing factor index in the Satrix stable for the year by a significant margin. However, these single-factor strategies can be very volatile. “You can almost view 2020 as a compressed view of what markets do over time, illustrating that factors are cyclical in nature.”

Williams said: “through these cycles, the Satrix SmartCore Index has been remarkably resilient, adding about 1.5% alpha in 2020, compared to Capped SWIX’s 0.5% return, illustrating the benefit of combining different factors into a portfolio.

“We construct SmartCore from a bottom-up perspective, by calculating an aggregate factor score for each of the stocks in our universe, which allows us to construct a portfolio with the strongest momentum, value and quality factor characteristics within a risk budget while limiting exposure to stocks which dilute the desired characteristics.”


ESG investing can make a positive impact

Williams said that contributing to global recovery and making the world a better place for the next generation to inherit is something that he believes should be on investors’ minds.

Peter Harrison – Schroders’ CEO – likened the impact of this to the changes to accounting standards adopted after the Great Depression.

“In 1929, a company’s profits were basically whatever a company decided to report. Because of the crash, that all changed in 1933 with the advent of GAAP accounting. At the time, everyone said it was going to kill capitalism, but of course, something very different has happened.

“I would argue that we are now witnessing the start of a new megatrend and that all profits are not all created equally,” Harrison said.

Work by Harvard Business School showed that some companies create more than a dollar of environmental damage for every dollar of their sales. “That is not reflected in their profits, and it needs to be. I think we all believe that the accounting profession will probably be the last to the party.”

“However,” said Harrison, “the way we need to view corporate profitability is their impact-adjusted profits. And the way asset managers need to be judged is on impact-related performance. That is, what is the investment performance after allowing for the externalities of that performance?”

How do we start ESG investing? “Outperformance should not be the objective, although it may occur as the ESG and green economy shift takes place. It is important to manage the risk in the process,” Williams said.


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Index-tracking investment in South Africa: What to consider in 2021