Marriott’s half year review
Simon Pearse, CEO of Marriott reviews the first half of 2009
The first six months of 2009 has been characterised by general investment inactivity. A "batten down the hatches" frame of mind seems to prevail. This is understandable after the financial shocks of 2008 and the consequent rapid descent into recession, leaving us all in a state of uncertainty and rendering "value" a confusing concept. If anything can be learned, it is that an asset with an uncertain income stream can lose a great deal of value very quickly.
If one is in search of assets that offer income certainty and acceptable value, the field in South Africa has narrowed considerably since the boom of recent years. Property income streams are now more uncertain than ever as the recession takes its toll on just about every industry. This, along with yields barely exceeding inflation, renders the asset class unattractive. The Bond market also yielding little more than inflation and facing a poorly funded government budget is equally as unattractive. Bank deposits, although offering negative real yields, may be a short term option while waiting for value to return to the other asset classes. This leaves the equity market. In recessionary times, reliable income streams are a key requirement, which points to those equities that influence their product pricing and operate in recession resilient industries – basic necessities like food, clothing, healthcare, and telecommunications amongst other things.
There are already signs that that the US is likely to lead the world out of the recession, however it may be a long road for all economies. International diversification is prudent, with value to be found in the larger capitalization equities as well as quality commercial and industrial real estate. Inflation is likely to gradually return to these economies making real returns difficult to attain through bonds or cash where yields are currently low. Again searching for equities and real estate securities that will produce reliable income streams and thus, valuable forward yields, is a task for astute analysts. It is interesting to note the absence of international property analysts in the market today; often a telltale sign that the asset class is worth looking at.
Marriott Portfolios: An update and the activity within them during the first half of this year
SA High Income Funds
These portfolios have around 70% exposure to bank deposits with terms to maturity between 9 and 12 months; the balance in cash. This has the effect of securing after fee rates at around 9% until the 2nd quarter of next year. We hope that this will give us the necessary time to be able to take advantage of anticipated price weakness in listed property and long bonds. A gradual move into real assets, as we enter the next phase of the investment cycle, will bring with it expected price volatility. Among the currently held term deposits are premium NCDs. These instruments may produce capital loss if held to maturity; however this loss will not exceed 3% of the capital value of the portfolios. As investors have enjoyed capital stability over the past 2 years along with high income distributions during the most trying of times; income stability at a net 9% yield with a small element of capital volatility remains, in our view, attractive to investors. Hopefully during the year ahead, re-investment into higher yielding securities will be possible thus enhancing distributions and paving the way for resumed capital growth.
SA Property Funds
Recession is seldom good for property. When tenants struggle, so do landlords. The decline in retail activity, together with an oversupply of space, is likely to impact rentals negatively. The general slowdown in economic activity is likely to temper the demand for both industrial and office space. These factors together with sharp increases in expenses suggest that growth in distributions from listed property will be curtailed. This has already become apparent with a recent decline in distributions from one of the major listed property companies. We remain of the view that listed property is expensive, particularly if the income growth is no longer sustainable. The Property Funds remain resilient in the current recession by maintaining the maximum cash holdings and a 30% hedge over capital. Although distributions are unlikely to grow, the high cash holdings will hopefully be reinvested at higher yields when appropriate.
SA Equities – Marriott Dividend Growth Fund
As discussed earlier, in recessionary times, reliable income streams are a key requirement, suggesting those equities that influence their product pricing and operate in recession resilient industries – basic necessities like food, clothing, healthcare, and telecommunications. The equities selected for inclusion in the portfolio have sustainable competitive advantages which enable them to retain and grow their customer base, protect margins, and increase, or at least maintain their dividend payments despite the current economic downturn. Selected businesses include household names such as Spar, Tigerbrands, Pick&Pay, Massmart, SAB, BAT, Mr Price, Clicks, Netcare, Altech and Vodacom. The fund is currently the top performing general equity unit trust in SA over the past year, returning a positive 15%. This result highlights the benefits of an Income Focused Investment Style, particularly when compared to the ALSI which is currently down over 24% for the year (as at 30 June 2009, verified by ProfileData).
International Equities
Our international equity and growth portfolios remain invested in global large capitalisation companies that, in our opinion, are best placed to withstand the current recession, and offer the best value as a recovery begins. Markets in the developed world have shown some stability over the last 6 months. There is a sense that the recession is drawing to an end in certain economies, particularly the US. The UK and Europe appear to have some way to go, however equity markets tend to preempt a recovery by some 18 months. Existing investors may well experience some respite from recent falls in value as earnings begin to recover. We remain of the view that the unusually high yielding income streams as well as the current rand strength present an ideal opportunity for new entrants into this asset class.
International Real Estate
This portfolio has undergone revision in order to remove real estate securities that now have poor earnings prospects and to consolidate into securities that offer attractively priced and reliable dividend streams. International real estate has suffered major declines in value over the past year, in some regions by as much as 70%. The effects of a sharp contraction in bank lending and the decline in demand for space has resulted in the earnings of many real estate companies being decimated. We are of the view that the forward yield of the portfolio is around 6%. This presents an opportunity last enjoyed by investors in the latter part of the 1990’s. Please bear in mind that property does tend to lag equities in the business cycle. Existing space needs to be filled before rentals rise to justify the cost of creating new space. We would consider the real estate opportunity more risky than that of an equity investment, which should be considered in one’s broad asset allocation decisions.
In summary, we are of the view that a gradual move back into real assets as economies begin to recover is a sensible investment strategy. One must be mindful of inflationary pressures that are likely to become evident in most economies. Positive real returns are likely to be achieved from equity, international real estate and in time local property, rather than bonds and cash. It is, however, imperative for us, that securities selected are able to produce reliable income streams and are purchased at acceptable dividend yields.
