Sanlam EmployeeBenefits

Sanlam Bonus Portfolios’Quarterly report as at 30/09/2019

ContentsHow our reckless conservatism could

ruin our retirement 2

Room for thought … 4

Economic Review 6

South African Money Market 10

International 12

Asset Allocation 14

Equities 16

Bonds 19

Smoothed Bonus Products 21

Product Information 23

Sanlam Progressive Smooth Bonus Fund 25

Record of Proxy Voting 28

Governance Structure 34

Financial Strength 36

Smoothed Bonus – Roles 37

Further Information 38

2

How our reckless

conservatism

could ruin our

retirementDanie van Zyl

Head: Smooth Bonus Centre of Excellence

Sanlam Employee Benefits: Investments

Many South Africans are buckling down and becoming increasingly cautious around all money matters

including investments. Given all the negative headlines in the media, it may make complete sense. However,

from a long-term saving perspective, it doesn’t. Retirement fund members, especially those with many years

before retirement, may think that by investing conservatively, mostly in cash and money market portfolios, they

are protecting themselves. In reality they may be recklessly impairing their retirement savings goals. We refer

to this phenomenon as “reckless conservativism”. Reckless conservatism can have big negative implications

for retirement down-the-line. So, somehow, South Africans must be bolder and fight a natural inclination to risk

aversion.

It doesn’t take much deep diving to find that South Africans are struggling. A quick landscape barometer paints

a depressing picture of imminent retrenchments and high levels of indebtedness.

A study from TymeBank suggests 76% of South Africans are out of money by the middle of the month.

When times get tough like this, many South Africans instinctively react by becoming conservative with their

money.

Danie van Zyl, Head of Guaranteed Investments for Sanlam Employee Benefits, says, “Our recently published

Benchmark Survey showed that South Africans’ financial resilience has been steadily decreasing for the last

three years. Additionally, the five-year return on the FTSE/JSE All Share Index has been muted at just 6.8%

pa. Our data shows that persistent poor investment returns and market volatilityleads to many South Africans

to overcompensate with reckless conservatism. This means that some retirement fund members, especially

younger members, aren’t invested aggressively enough in the market. Our surveys over the past few years

have also shown that members seldom re-evaluate their investment strategy and may therefore inadvertently

remain conservatively invested for many years, losing out on returns.”

Boitshepo Gaitate, a behavioural economist from Genesis Analytics, highlights loss aversion as one of the key

drivers behind this conservatism. “Given that we typically feel the sting of losses twice as strongly as we feel

the joy of equal gains, we tend to lean towards conservative investment choices.

Additionally, with volatile economic performance, the representa-

tiveness heuristic bias contributes to our unbalanced reaction to

changes in economic indicators. We are constantly falling into the

trap of believing that certain events are more heavily-linked to

investment performance than they actually are in reality.”

The implications of reckless conservatism.The biggest risk is not being able to save enough for retirement. An overly conservative portfolio severely

reduces the likelihood of decent returns because there’s limited market exposure. Van Zyl says cash,

especially, struggle to provide a meaningful real return over the long-term.

It is not only younger members who struggle with the temptation to be ultra-conservative. Members who at

retirement opt for a living annuity on average still have a 20 – 30 year investment horizon. Too many of

these members cannot stomach a market downturn and invest too conservatively in retirement.

So how do we overcome our risk aversion?Gaitate believes that it comes down to i) how investment journeys are positioned and framed, ii) increasing

the likelihood of closing any intention-action gap through the use of commitment devices, and iii) a bit of

handholding. “Positioning investment journeys from the standpoint of future losses if one does not stay the

course - as opposed to highlighting gains – makes for more impactful conversations around investment

behaviour and improves long-term investment perceptions. While many people intend to make better

provisions for retirement, affordability is often a barrier. In a TED talk by Daniel Goldstein, commitment

devices are outlined as good tools for encouraging behaviour change towards better choices.”

The power of reassurance should not be underrated. Sometimes, we need an external person like a

financial adviser to give us a little push to be bolder when it’s in our best interests. While South African’s

are struggling to push through a difficult landscape, their mental bandwidth to make the right investment

choices becomes increasingly limited, says Gaitate. Advisers have a key role to play in this regard.

Van Zyl agrees and adds that there are ways to combine a conservative and more aggressive approach,

which should satisfy our desire for conservatism plus the need for market exposure. “A Living Annuity is a

good example. One of the worries is that few of us know if the day we retire will coincide with a market

crash. If it does, a portfolio can lose 15%-20% of its value overnight. If you continue to draw a fixed

retirement income from the living annuity it will have a lasting negative effect and reduce the amount of

income you can withdraw over your lifetime. This is because you are selling more “cheaper” units in your

portfolio to fund your income, thereby reducing the number of units that are available to participate in a

subsequent market recovery. However managing your living annuity with a protection component

(portfolios protecting against negative investment markets) and a market-related Component (a selection

of moderate aggressive to aggressive portfolios) can reduce this risk. The strategy involves drawing your

retirement income from the protection component, which means it’s protected from any market volatility. It

also means the market-related component is not income-linked, so has time to recover and keep yielding

you real long-term returns.”

He says smooth bonus portfolios are increasingly being used by worried retirement fund members. “These

portfolios can give you the peace of mind to invest in growth assets such as equities and property as your

investments returns are “smoothed”. The benefit of smoothing is that members get stable, more

predictable returns, so you don’t suffer from short-term market volatility.”

How does smoothing work? It delivers stable returns through monthly bonuses. In periods of strong

investment performance, some of the underlying investment return is held back. This then supplements

bonuses in periods of lower growth. So, regardless of the market, returns are stable.

His last words to South Africans?

“Fortune favours the brave. Seek a trusted partner to be alongside you on the journey

and give you the reassurance you need. A financial adviser is the ideal person to guide

you to get more comfortable with risk.”

3

.

Room for thought …

Sustainable Investing

In less than three months the next decade will be ushered in. While it presents us with an opportunity to

examine the decade that has passed, it also allows us to look forward and consider which trends will

transform the local and global asset management industry. There is growing consensus that sustainable

investing is going to become a mainstream discipline and a key trend in the 20s. Regulators across the

world have already set their expectations for the industry’s players with requirements of greater

transparency, investment process integration and reporting. Sustainability factors have also shown

evidence of enhancing performance within integrated investment processes over those that do not, while

avoiding risks that may not have been avoided otherwise.

In June 2019 the Financial Sector Conduct Authority issued Guidance Notice 1 of 2019: Sustainability of

Investments and Assets in the Context of a Retirement Fund’s Investment Policy Statement. In conjunction

with Regulation 28 it states that a fund should consider all factors that may materially affect the long-term

performance of any asset it invests in. While environmental, social and governance (ESG) factors,

alongside economic drivers, headline the considerations that are heeded, they do not form the exhaustive

list. The Guidance Notice states that, in respect of domestic assets, ESG factors also relate to the

advancement of broad-based black economic empowerment. The expectations from the regulator are that

a retirement fund’s process will be able to test areas of evaluation, monitoring and ‘active ownership’ in

pursuit of its sustainable investment objectives.

There are various strategies that can be called on when implementing a sustainable investing framework.

Retirement fund trustees will require a complete understanding to select strategies that are fit for purpose:

• Negative screening: An investor purposefully filters out the companies/entities that they deem to have a

negative effect on society. This approach may exclude industries involved in tobacco, thermal coal,

arms or gambling. Norms-based screening is related in approach, but excludes companies that break

international conventions.

• ESG integration: This approach is the most commonly used. Traditional investment analysis and

decision making at the individual instrument level is augmented with ESG performance indicators.

Another related approach, the ‘best-in-class’ ESG overlay, tilts towards specific ESG scores relative to

the overall market or industry peers within a quantitative or index approach.

• Thematic investing: As the name suggests a specific sustainability theme is selected, such as climate,

housing or water, based on a financial/economic motive or clients’ need to align the portfolio with their

specific values.

• Impact investing: This approach places money with entities that intentionally target measurable social or

environmental projects with direct impact.

While the challenges are significant, the leading sustainable asset management practitioners will develop

an authentic and credible approach articulating how sustainability is rooted in their investment philosophy.

By Jason Liddle

Head of Institutional Distribution

Sanlam Investments

4

Evidence-based proof of its integration in their investment approach, process and outcomes should support

their credibility. ‘Active ownership’ is a key area within the framework where engagement, intervention and

voting act as the voice of the investor. While comprehensive proxy voting guidelines/policies and a

disciplined and robust engagement approach are the table stakes, influence over the decision making of the

company’s board is the ultimate desired outcome. Sanlam has continued to provide a respected ‘voice’ on

behalf of our clients for many years targeting better outcomes. rustees need to avoid thinly-resourced

functions that focus more on compliance and instead employ authentic practitioners that drive a mandate to

activate, enable and equip investment professionals in making better decisions, using a sustainable investing

lens. Sanlam Investments has and continues to invest in new tools and the right talent to harness ESG data

and drive our internal research. Asset managers will also look to differentiate themselves by expanding their

ESG investment process reach to all asset classes – an important requirement or expectation from the

regulator.

The much-publicised failures of corporate governance in certain South African companies have led to

significant and impaired losses shared by retirement fund members. The improved and focused lens of a

disciplined sustainability framework should limit the likelihood of a similar experience. Addressing the

domestic socioeconomic imbalances is another area in which sustainable (impact) investing can play a

strong role. At Sanlam Investments, we are committed to our investors in helping them achieve their

sustainable investing objectives.

5

EconomicReview

By Arthur Kamp

Chief Economist

Sanlam InvestmentsGlobal

The mature global economic expansion battled to

maintain momentum in the third quarter of 2019.

Industrial production remained stagnant, while the

global services PMI data suggest services activity

has softened too.

On balance, the global all industry PMI (which

combines the manufacturing and services PMIs)

suggests world GDP was advancing at around

2.5% annualised late in the third quarter. At least,

there are tentative signs the all-industry PMI output

series has stabilised, even though the underlying

details on new orders and employment show a

decline through the third quarter. This suggests a

meaningful lift in output is not imminent in the

fourth quarter.

There are any number of culprits blamed for the

slowdown in activity, including escalating trade

protectionism, the fading impact of US fiscal

stimulus, increased uncertainty due to looming

events such as Brexit, and other political risks. The

latter includes Hong Kong where protests have

coincided with weaker retail spending and tourism

receipts.

Another political focal point is the ongoing Brexit

saga in the UK. Amid the gridlock, UK members of

parliament passed the ‘Benn’ Act in September

2019, which will compel Prime Minister Johnson to

request, by 19 October 2019, an extension to

Article 50 from 31 October 2019 to 31 January

2020, unless a deal is reached or members of

parliament vote to leave the European Union (EU)

without a deal. At present, an extension seems to

be the most likely outcome, along with a potential

call for an early election – although nothing is

certain.

The uncertainty surrounding the Brexit impasse is

clearly reflected in the Bank of England’s

September 2019 Monetary Policy Statement. The

bank warned that a no-deal Brexit would likely

weaken GDP growth, depreciate Pound Sterling

and push inflation higher.

On the other hand, the bank noted a ‘smooth’ Brexit

scenario would likely create excess demand

pressure in the medium term, which would warrant

‘gradual’ increases in interest rates. Faced with

these diametrically opposed possible outcomes, the

bank’s Monetary Policy Committee left the official

bank rate unchanged at 1.75%.

The developments above have been reflected in

weak business confidence surveys and stalling

capital expenditure. In turn, the dearth of new

investment growth has filtered through into softening

global employment growth. Meanwhile, the

moderation in jobs growth has slowed the advance in

retail spending, which had been especially strong

early in 2019.

In the US, non-farm payrolls have recorded firm

growth since around 2012. However, the annual

advance in payrolls softened significantly from 1.7%

in April 2019 to 1.4% in August 2019. The

unemployment rate edged higher to 3.7% in June

2019 (and remained unchanged in July and August)

from a possible cyclical low of 3.6% in May 2019.

This emerging softness in the labour market follows

a significant prolonged decrease in the level of

company profits relative to GDP, as measured in the

US national accounts, from 12.4% of GDP (with

inventory value adjustment and capital consumption

adjustment) in 3Q14 to 9.8% of GDP in 2Q19

(although the ratio did improve a bit in the second

quarter from 9.5% of GDP in 1Q19).

Monetary policymakers have responded to the

slowdown, led by the US Federal Reserve (Fed),

which is not only cutting its policy interest rate, but is

also set to expand its balance sheet once again. In

decreasing the target range for the federal funds rate

to 1.75-2.0% on 18 September 2019, the Fed listed

‘the implications of global developments for the

economic outlook as well as muted inflation

pressures’ as reasons for its decision. This follows

the Fed’s earlier decision to end its balance sheet

normalisation early.

6

In Europe, where a decisive downturn in

Germany’s leading indicator does not portend

anything good on the growth front, the European

Central Bank Governing Council cut the interest

rate on its deposit facility by 10 basis points to -

0.50% in September 2019, in addition to rebooting

its asset purchase programme at a pace of €20

billion per month as from 1 November 2019. At

this stage the programme is open-ended. Other

measures included the implementation of a two-

tier system for reserve remuneration in which part

of the banks’ holdings of excess liquidity will be

exempt from the negative deposit facility rate.

Elsewhere, developed market monetary policy

easing helped encourage emerging market

central banks to loosen policy. In India, in an effort

to arrest a weakening private sector credit

extension trend, amid a high level of non-

performing corporate loans, the Reserve Bank of

India cut its policy rate more aggressively than

expected in August 2019 by 35 basis points to

5.4%, and by a further 25 basis points in early

October 2019. The bank is likely to cut further,

given a contained inflation outlook, while also

providing liquidity to non-bank financial

corporations and banks if needed. At the same

time, corporate tax rates were cut underlining the

authorities’ concern about growth prospects

against the backdrop of moderate investment

spending.

In China, the People’s Bank of China also eased

monetary policy in September, cutting reserve

requirements and lending rates in response to

softening activity, including a slowdown in the

annual advance in industrial production to 4.4% in

August 2019 and weak export performance. The

approach of the bank is, nonetheless, cautious,

given the objective of deleveraging the economy

and maintaining financial system stability.

One immediate problem for China is the ongoing

deterioration in its trade relations with the US. On

1 September 2019, the US applied an additional

15% tariff on more than $100 billion of its imports

from China. Further tariff increases are expected

in the fourth quarter.

Nonetheless, we should not overlook another

underlying structural cause of China’s growth

slowdown as reflected in softer fixed investment

spending relative to GDP. Admittedly, to a

significant extent, weaker investment expenditure

must reflect the ongoing trade dispute. In

response, this may prompt an acceleration in

public sector fixed investment spending.

But, over and above this, China’s growth boom in

the opening decade of this century, which

underpinned the so-called commodity ‘super cycle’

at the time, left the country with a high level of

capital stock relative to GDP along with a high

investment ratio. This was bound to culminate in

slower productivity and, hence, overall GDP growth.

It is not clear whether the slowdown in global growth

will intensify in the quarters ahead. To start, in the

US, inversion of the US yield curve has historically

not been a good omen. Also, more broadly, belief in

the ability of monetary policymakers to sustain

growth is wearing thin.

In addition, in the UK, a no-deal Brexit – if it occurs –

would not only weigh on growth in the UK, but also

Europe more broadly. And, any further intensification

of trade protectionism would likely continue to

depress business confidence levels and investment.

It is not only China which is being targeted for tariff

increases. The US is set to decide on tariffs on auto

imports in mid-November 2019. Barring exclusions,

Europe would be hit if tariffs are imposed.

By the same token, the intensification of US import

protectionism must be hurting the US economy itself.

In an economy with surplus capacity tariff increases

could prompt a lift in import-competing production.

However, the US economy has been operating at or

close to full capacity. If import-competing industries

are to take advantage, resources must be shifted

from export-competing industries, implying no net

gain in production. Indeed, tampering with the

optimal allocation of resources under a free trade

system can be expected to lower productivity,

leaving growth weaker and inflation higher than it

otherwise would have been.

The US and China have been two key growth

engines for the global economy in recent years. But,

neither is expected to gather stronger momentum

heading into 2020, especially if the trade conflict

continues to escalate.

On a more optimistic note, the shift towards trade

protectionism, while damaging, is not uniform across

all regions. Moreover, although softer, the ratio of

US corporate profits to GDP remains relatively high,

while the absence of inflation pressure implies

monetary policy is likely to be loosened further in

both developed and emerging markets. This may be

enough to avoid a material further slowdown in

global economic activity.

7

But, there is a caveat. Inflation must remain

subdued. On balance, this is the case, although it

should be noted the US core consumer price

index (CPI) advanced at a firm clip of 0.3% per

month from June 2019 to August 2019. This has

not been reflected to the same extent in the core

personal consumption expenditures deflator,

which the Fed targets, given different weights for

key items such as healthcare. Nonetheless,

should this pace be maintained into 2020, the Fed

is likely to find it more difficult to argue the case for

maintaining an excessively loose monetary policy?

In any event, since the belief in the ability of

monetary policy to drive growth is wearing thin,

the point is it is not altogether clear what could

initiate an improvement in growth heading into

2020. If activity fails to lift and employment growth

continues to slow, attention will increasingly turn to

fiscal policy as a potential lever.

Very low or negative real interest rates in

developed markets make it easier for the fiscal

maths to add up, implying some space for fiscal

expansion even if debt levels are high. But, this is

only the case if real interest rates remain

depressed. Also, the sharp increase in

government debt levels since the global financial

crisis, against a backdrop of a decline in public

sector capital stock relative to GDP, implies

government balance sheets have weakened.

Accordingly, any fiscal expansion must focus on

capital expenditure (including human capital), to

protect government balance sheets and to lift long-

term potential growth.

Ultimately, though, the underlying problem for the

developed economies is low productivity growth

since the global financial crisis in addition to

ageing workforces. Absent a marked improvement

in productivity, the impact of monetary and fiscal

policy on potential growth has limits.

South AfricaThe most significant economic development in the

third quarter was the release of the National

Treasury’s economic growth strategy for public

comment in late August 2019. The document was

subsequently discussed and, by and large,

‘endorsed’ in principle at the ruling ANC party’s

National Executive Committee meeting in late

September 2019. This does not imply the paper’s

recommendations will be implemented as is.

There is, for example, still considerable

uncertainty around the funding model for

financially unsound state-owned companies

(SOCs), notably Eskom. But, overall, this is a

significant step in the right direction.

At its core, the document proposes a social

compact, which is essential if the economy is to

succeed. It has debatable policy prescriptions, but

these do not distract from its key message, which

is promotion of competitiveness and productivity –

the ultimate drivers of economic growth. Further, it

recommends restructuring and privatisation as a

means to address failing SOCs. And, it is firmly

supportive of consistent, sound macroeconomic

policy – as opposed to attempting to boost growth

in the short term through inappropriate fiscal and

monetary policies, leading to even worse long-term

economic outcomes. The paper also recognises

that regulatory barriers to entry are inhibiting

growth of micro, small and medium enterprises

(SMMEs) and recommends exempting SMMEs

from certain laws, notably labour laws. There is

welcome emphasis on reducing red tape.

In the interim, data released by Statistics South

Africa show real GDP advanced 3.1% seasonally

adjusted and annualised in 2Q19, following an

outright decline of 3.1% annualised in 1Q19. Fixed

investment spending, at least, recorded a positive

increase of 6.1% annualised, from a low base.

Consumer spending was also positive, increasing

2.8% annualised – in line with the 2.4% advance in

real personal disposable income. South Africa’s

terms of trade slipped in the second quarter, but

the improvement in the third quarter, implied by the

fall in oil prices relative to the prices of key

commodity exports, should provide support to

domestic purchasing power. Nonetheless, it is

evident that the supply-side of the economy

remains weak, as the improvement in domestic

demand has been accompanied by a deterioration

in the current account deficit from 2.9% of GDP in

1Q19 to 4% in 2Q19.

Subsequent data releases in the third quarter,

including a plunge in the manufacturing PMI to a

level of 41.6 – its lowest level since the global

financial crisis – confirm the second-quarter GDP

bounce in large part reflects a degree of

normalisation following electricity outages in the

first quarter.

Meanwhile, the subdued level of investment

spending, reflecting depressed business

confidence levels, weak profits growth (4.8% year-

on-year in 2Q19 in current prices) and an

inadequate rate of return on investment, helps

explain South Africa’s high unemployment rate,

which climbed to 29% in 2Q19. Worryingly, the

country’s structural unemployment rate is above

20%. Even during the period of sustained strong

real economic growth in the early 2000s the

unemployment rate remained above this level.

8

The weakness of the labour market is reflected in

the tepid 4.8% advance (current prices) in total

worker remuneration in the year to 2Q19. Along

with a record high effective personal income tax

rate, in aggregate, and high real interest rates,

soft remuneration growth remains a constraint on

households, although the country’s improved

terms of trade, if sustained, should help.

On balance, real GDP growth is expected to

advance by just 0.6% in 2019, followed by some

improvement to 1.5% in 2020, provided the terms

of trade remain elevated and global growth holds

up at its current level. The balance of risks,

however, appear tilted to the downside.

Against the background of soft economic activity

and high real interest rates, the South African

Reserve Bank (SARB) is beginning to guide

actual inflation outcomes (and inflation

expectations) lower. Core inflation (CPI excluding

food and non-alcoholic beverages, fuel and

energy) advanced by just 4.3% in the year to

August 2019, while headline CPI also

increased 4.3%. Looking ahead, headline CPI is

expected to average 4.3% in 2019 (4.7% year-

end) and 5% in 2020 (5.1% year-end) with a

temporary peak of 5.3% in February 2020.

Ostensibly, this should provide the SARB with

some room to ease monetary policy. But, the

bank left its repo rate unchanged at the

conclusion of its Monetary Policy Committee

(MPC) meeting in September 2019, as South

Africa’s deteriorated fiscal position gives pause

for thought.

Looking ahead, a benign inflation outlook

(especially for core inflation), the tilt towards

monetary policy easing by central banks around

the globe, as well as the slow pace of income

growth and private sector credit extension growth

may prompt an interest rate cut of 25 basis points

when the SARB’s MPC meets in November. But,

much will depend on the content of the October

Medium-Term Budget Policy Statement (MTBPS)

and the behaviour of the Rand.

Currently, the Rand is trading at more than a

standard deviation weaker than its current estimate

for purchasing power parity (PPP)

(Rand/US$13.35). Assuming the SARB continues

to do what is required to anchor inflation

expectations we expect the Rand to converge on

its PPP level over time. The PPP year-end

estimate for the Rand at end 2020 is

Rand/US$13.70.

Heading into the fourth quarter, though, fiscal

policy remains a focal point. South Africa’s fiscal

metrics have deteriorated and the modest

economic growth rate projected into next year is

insufficient to help stabilise the government’s

financial position. Another significant revenue

shortfall is expected in the current fiscal year.

Indeed, a main budget deficit of around 6% of GDP

is forecast for both 2019/20 and 2020/21 on current

information due to increased bailouts to Eskom and

persistent low income growth (compared with the

initial budgeted deficits of 4.7% of GDP in 2019/20

and 4.5% of GDP in 2020/21). At the same time,

the government debt ratio is forecast to continue

climbing well above 60% of GDP in the medium

term (around 70% of GDP including its debt

guarantee exposure). This underlines the

importance of the upcoming October MTBPS.

9

South AfricanMoney Market

By Donovan van den Heever &

Johan Verwey

Portfolio Managers

In the second quarter, SA’s gross domestic product (GDP) grew by 3.1% year-on-year (y/y), recovering almost fully

from the similar sized dismal contraction in the first quarter. The factors responsible for the recovery were

predominantly the opposite of those in 1Q2019, namely recovery from a low base and the positive impact of

reduced power cuts by Eskom on mining and manufacturing production.

Headline CPI inflation remained surprisingly low over the quarter, improving to 4.3% y/y in August, from 4.5% y/y in

June. In July it was even as low as 4% y/y, mainly as a result of lower fuel price inflation and also surprisingly lower

electricity and food price inflation.

With inflation at lower levels, the South African Reserve Bank (SARB) cut the repo rate with 25 basis points (bps) at

its July Monetary Policy Committee (MPC) meeting, from 6.75% to 6.50%, providing the economy with much-

needed support. At its September MPC meeting, the SARB kept the repo rate unchanged at 6.50%, following a

unanimous vote. They are of the opinion that risks to the inflation outlook are balanced. Their 2019 inflation forecast

was lowered to 4.2%, the 2020 forecast remained unchanged at 5.1% and the 2021 forecast was increased slightly

to 4.7% from 4.6%. They kept the 2019 growth forecast unchanged at 0.6%, lowered the 2020 forecast to 1.50%

from 1.80%, and lowered the 2021 forecast to 1.80% from 2%. Speaking to Bloomberg earlier in the month, SARB

Governor Lesetja Kganyago mentioned that the jump in GDP was from a low base, and consequently the SARB is

not changing its 2019 growth forecast of 0.6%.

Eskom remains the biggest risk for the SA economy, which was reiterated again with the release of their FY2019

results, recording a R20.7 billion loss. Early in the quarter, Finance Minister Tito Mboweni tabled the Eskom Special

Appropriations Bill, which provides for an additional R59 billion for this fiscal year and 2020/21. They also did not

provide any information on the planned unbundling and reform. The Chief Restructuring Officer was only appointed

at the end of July. This shows that they are struggling to come up with solutions on how to take the struggling

parastatal forward. National Treasury also announced that they will increase its weekly SA government bond

issuance by R1.51 billion, of which a substantial portion will be used to support Eskom.

At the Sub-Saharan summit, Moody’s stated that the chances of a downgrade in the next 12-18 months are small.

According to them, worst-case fiscal metrics are 70% debt to GDP and a fiscal deficit of 7% of GDP, and the best

case is debt to GDP of 65%, which is still similar to other BBB- rated countries at 60%. The Moody’s rating outlook

is currently ‘Stable’, but there is a good chance that it can be changed to ‘Negative’. National Treasury recently

issued US$5bn of Eurobonds, which will help to reduce SA’s fiscal deficit significantly.

Market review

10

Government is close to finalising a programme for the redistribution of state-owned land. If implemented

successfully, this will be positive for the economy, investors and rating agencies. President Cyril Ramaphosa

also recently announced the appointment of an Economic Advisory Council which will aid the government and

Presidency in the development and implementation of growth-boosting policies.

During the quarter the US Federal Reserve cut interest rates twice by 25 bps. They stated that this is not

necessarily the start of an extended rate cutting cycle. The objectives of the rate cuts are to insure their economy

against downside risks from weak global growth and trade policy uncertainty, to help offset the effects that these

factors currently have against the economy, and to promote a faster return of inflation to their 2% target. The

European Central Bank also cut their benchmark interest rate by 10 bps and restarted their stimulus programme,

intending to buy €20 billion of bonds per month.

Core CPI remained unchanged at 4.3% y/y during the quarter. PPI inflation decreased from 5.8% y/y in June to

4.5% y/y in August. The Rand weakened to 15.17 against the US Dollar from 14.11 during the quarter. The 10-

year SA government bond yield weakened to 8.92% from 8.69%. The trade balance increased from a surplus of

R2.1 billion to one of R6.84 billion. The unemployment rate increased from 27.6% in 1Q2019 to 29% in 2Q2019.

The money market yield curve shifted down after the 25-bps rate cut in July. After the September MPC meeting,

where the SARB kept the repo rate unchanged, the curve steepened a little again. Now, with the SARB’s inflation

expectations for 2020 and 2021 still being above the midpoint (4.5%) of the target range (3-6%), the market is

only expecting one 25-bps rate cut over the next year.

What SIM did

All maturities were invested across the money market yield curve, exploiting the term premium as well as adding

some higher-yielding fixed-term negotiable certificates of deposit (NCDs). Quality corporate credit, which traded

above the three-month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes

in the portfolio together with some fixed-rate NCDs. The combination of corporate credit, high-yielding NCDs and

floating rate notes will enhance portfolio returns.

SIM strategy

Our preferred investments would be a combination of fixed-rate notes, floating rate notes and quality corporate

credit to enhance returns in the portfolio. Although the curve steepened a little, fixed-rate notes are still not

providing enough compensation for their additional interest rate risk compared to floating rate notes.

11

6.346.63

6.79

7.287.43

7.66

6.59

6.91 7.03

7.47.58 7.74

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

0 1 3 6 9 12

Yie

ld

Months

Money Market Yields

30 Sep 19

30 Jun 19

Source: I-Net

International

By Justin Greeley

Head of Fund Solutions

Sanlam Investments

Market reviewThe first half of 2019 saw markets make good

progress, and so it was always going to be a

challenge for the third quarter to continue at the

same pace. The duration of the economic cycle is

clearly playing a role in investors’ expectations for

the future, and this has been coupled with an

identifiable slowdown in global economic activity.

The US–China ‘trade war’ escalated during the

third quarter, to such an extent that markets were

relieved when, in early September, the two sides

agreed to recommence trade talks. However, the

preceding tensions and uncertainty have certainly

plagued markets over the third quarter. For now,

the timing of any resumption to the dispute remains

unclear. At a fundamental level, even more

concerning has been the clearly identifiable

slowdown in global economic growth, which now

appears to be materially impacting the US,

although not yet pulling the entire economy to

recessionary levels. The trade dispute is clearly a

factor in this, but the broader slowdown in China is

also worth noting.

In response to the economic slowdown, the US

Federal Reserve implemented two interest rate

cuts during the quarter. These can be seen as pre-

emptive moves to prevent any further material

deterioration and to boost confidence. However,

the impact of these cuts has yet to be felt, but also

needs to be seen in the context of the low interest

rate environment since 2009. In Europe, the

European Central Bank also paved the way during

the quarter for the announcement of a range of

monetary easing measures in September, including

a formal interest rate cut. These moves in the front-

end of the bond curves helped support longer-

dated moves across the curves and so the quarter

generally saw a move down in developed market

sovereign bond yields. Elsewhere, Brexit remains

unresolved, and may not be by the current deadline

(at the time of writing) of 31 October.

Volatility has picked up during the quarter, especially

during August, but has not reached levels outside

current normal bounds. On the geopolitical front the

attacks on Saudi oil facilities in September led to a

spike in the oil price, but this quickly reversed within a

few days.

Despite the clear macro challenges, equity markets

did move higher during the quarter, posting a gain of

0.53% for the period, as measured by the MSCI

World Index. This clearly masked the intra-quarter

volatility, which saw equity markets gain 0.50% in

July, but then fall back by 2.05% in August, only to

recover 2.13% in September – a bumpy ride. The

2019 year-to-date returns record a healthy 17.61%

return, but this also encapsulates the recovery from

the fourth quarter of 2018, and so the one-year

returns are significantly more modest at 1.83%. At a

regional level there was clear differentiation during

the quarter in US Dollar terms. Japan led the way

rising 3.13%, while North America gained 1.36%,

thus also outperforming the wider market. However,

Europe declined 1.80%, but it was the Pacific

excluding Japan region that took the major fall,

decreasing 5.20% for the period – the protests in

Hong Kong being a significant factor. More broadly,

emerging markets declined by 4.25% for the quarter,

and hence are lagging their developed market

counterparts by almost 12% for 2019 so far.

Turning to global sectors, it was clearly evident that it

was a defensively-led rally that helped markets to

progress for the quarter. Utilities were the best

performing sector rising 6.45%, followed closely by

Real Estate gaining 6.22%. Consumer Staples was

then the next best sector returning 4.01%. However,

then there was another step down to Information

Technology and Communication Services, which

delivered 2.26% and 1.36% respectively. Together,

these were the sectors that outperformed the broader

market. In sharp contrast the Energy sector fell

5.78%, while Materials were down 3.26%.

12

Healthcare, somewhat surprisingly, was the next

weakest sector declining 1.25%, though Industrials

also posted a decline of 0.68%. Consumer

Discretionary and Financials both managed to

generate positive absolute returns of 0.26% and

0.28% respectively, although both underperformed

the wider market.

Like equity markets the strong performance of

bond markets year to date looked unsustainable,

but bond markets, as measured by the Bloomberg

Barclays Global Aggregate Bond Index, did post a

positive return of 0.71% for the quarter. This was

driven by the overall downward movement in

sovereign yields. July saw bond markets decline

by 0.28%, while August saw a strong return of

2.03% in a month that was clearly risk-off. Then

September witnessed many of those returns being

eroded as bond markets declined 1.02% for the

month. As a result, for 2019 year-to-date global

bond markets have delivered a return of 6.32%,

and 7.6% over the last one-year period.

The US 10-year Treasury started the quarter with a

yield just above 2%, but this fell below 1.50% during

August, before recovering above 1.80% in

September, before falling again in the second half of

September to end the quarter in the 1.6% to 1.7%

range.

Within the global corporate bond space, the

continuation of lower yields and a reasonable, but

slowing, economic picture enables global corporates

to outperform the wider bond market. For the quarter,

the Bloomberg Barclays Global Aggregate Corporate

Bond Index rose 1.21%. Unlike the wider market it

just managed to produce a positive return in July, but

like the broader market saw most of its gains

reversed in August, before pulling back somewhat in

September. For 2019 to date, global corporates have

delivered over a 9.5% return.

All performance numbers are in US Dollars unless

stated otherwise.

513

AssetAllocation

By Gerhard Gruywagen

Chief Investment Officer

Sanlam Investments

Our positioning

Local investmentsRelative to other emerging markets with a similar

sovereign credit rating the real returns on offer

from South African assets are attractive. They are

also favourably priced relative to their history. For

this reason, we have an overweight position in SA

assets funded by SA cash.

Local equities

We retained our overweight position in South

African equities, counterbalanced by an

underweight position in international equities,

which is overvalued in our opinion.

Based on consensus earnings forecasts, the one-

year forward price-to-earnings (P/E) ratio of our

benchmark (50% SWIX, 50% Capped SWIX) has

now dropped to 11, if we exclude Naspers and

Prosus. With Naspers and Prosus, it is at 12.3.

The current dividend yield of the market,

excluding Naspers and Prosus, is at 4.95%,

which is the highest it has been since 2008.

Local bonds

We maintained our overweight position in SA

bonds. SA 10-year bonds are trading at a nominal

yield of 8.85%. Assuming a long-run inflation rate

assumption of 5.25%, they are offering a long-run

real return of 3.6%.

Inflation-linked bonds

We retained our overweight position in inflation-

linked bonds. The 3.4% real yield of 10-year

inflation-linked bonds is very attractive. Since

1900, conventional SA bonds gave a real return

of about 2%. Inflation-linked bonds do not carry

the risk of unexpected inflation, as is the case

with conventional bonds.

Local listed property

SA domestic listed property companies are priced for

significant future dividend cuts. We think the

markets’ expectations of the size of future dividend

declines are somewhat overdone.

This view is expressed through a small overweight

position in the three largest SA REITs, namely

Growthpoint, Redefine and Hyprop. They have a

current average dividend yield of 11.7%, and a one-

year forward dividend yield of 10.4%, which are

attractive relative to bonds yields.

Global investmentsEven though the Rand is undervalued against

developed market currencies, we do not think this

undervaluation is significant enough to introduce an

overweight position in Rand assets relative to

offshore assets.

Global equities

We maintained our underweight position in global

equities. US equities are expensive when using long-

run valuation measures. The US market’s Graham

and Dodd P/E multiple, price-to-book ratio and profit

margins are well above their long-run means. On a

relative basis, European and UK equity markets are

cheaper in terms of these traditional valuation

measures.

The dispersion in the P/E ratios of stocks on both the

US and European markets are at historical highs.

One would expect the P/E ratios to differ between

shares, as the companies have different growth

prospects.

14

When the P/E dispersion is at extreme lows, it

means that all companies trade at a very similar

P/E ratio. As not all companies have the same

earnings growth prospects, it is unlikely that all of

them are correctly priced in this case. Ample

opportunities should therefore be available for

active managers.

When the P/E dispersion is at extreme highs, as is

the case now, it implies that the dispersion in the

expected earnings growth of companies is at high

levels relative to history. Possibly more stocks than

usual are therefore mispriced because of unrealistic

earnings growth expectations – whether too high or

too low.

The technology sector in the US is trading at a high

P/E multiple. We are of the view that it is pricing in

too much growth relative to technology sectors in

emerging markets, and particularly in China. We

therefore have an overweight position in emerging

market technology stocks to compensate for our

underweight position in US stocks.

We also believe that the growth prospects of the

financial sector in Europe are underestimated and

therefore we have a small overweight position in

this sector. European financial companies are

extremely cheap versus their history, they are

attractive relative to financial companies in other

markets, and they are also cheap relative to other

sectors in Europe.

Global bonds

We have an underweight position in global bonds in

preference to international cash. We believe a fair

long-run real return from developed market

sovereign bonds is 1%. Currently, global developed

marked bonds are priced well below this, based on

an inflation expectation of about 2% – a level that is

implicitly targeted by the central banks.

Even though being underweight in global bonds

makes sense from a pure long-run valuation

perspective, we are concerned that long bonds

might stay mispriced for a considerable time.

During the past quarter we therefore reduced the

magnitude of this underweight position by

specifically adding to US long bonds.

US long bond yields are currently high relative to

most other developed markets.

Ten-year yields are negative in, for example, Japan,

Germany, France and Switzerland.

Periods of positive GDP growth have always been

followed by recessions. The US is experiencing the

longest economic cycle in its history with 122

months of positive real GDP growth. Typically,

monetary policy and fiscal policy are used to combat

recessions.

These tools were used extensively over the past

decade in fear of a depression after the 2008

financial crisis.

More than 10 years later, the fiscal situation of

developed market governments has not improved.

The balance sheets of central banks remain inflated

following quantitative easing and policy rates remain

very low. Therefore, fewer tools are currently

available for combatting a future recession.

In response to a slowdown in the US economy it is

therefore possible that the US Federal Reserve

might introduce negative policy rates as we have

seen in a few other countries. Long bond yields can

be regarded as an expectation of future short-term

interest rates plus a risk premium. So, if short-term

interest rates are expected to remain low for a

protracted period due to central bank actions, long

bonds could become mispriced on a relative basis.

Global property

We have a 0.5% holding (an overweight position) in

a global developed market portfolio of developed

(rental-yielding) REITs. The portfolio’s one-year

forward dividend yield is about 4.6%, with positive

rental growth prospects. The rental-yielding REIT

sector is attractive relative to global developed

market bonds. However, as listed property assets

are considerably more volatile than developed

market bonds, we opted for a modest overweight

position given our current concern about the

valuation of developed market equities.

Risks and

opportunities aheadAs discussed above, globally we are concerned

about the impact of a recession on the world

economy, especially as it is unclear how

policymakers would and can respond to alleviate the

blow.

Locally the funding difficulties at Eskom remain a

major risk. Thus, even though South African

domestic assets appear cheap, they might be

appropriately priced given South Africa’s electricity

supply issues.

15

EquitiesBy Patrice Rassou Head of Equities

Sanlam Investments

An Eye for an Eye

Global overviewThe US Federal Reserve (Fed) cut rates for the first time in over a decade at the end of July, but this did not prevent

President Donald Trump from castigating Fed Chair Jerome Powell for being behind the curve. The US economy has

weakened but is not in a recession due to fiscal support offsetting the adverse impact of the trade war. The inversion of

the US yield curve is perceived as sounding the toll for a near-term global recession. The trade war impact is real with

US imports from China down 15%, while Chinese imports from the US are down 30% year-on-year. As the economy

drifts lower as a result of lower manufacturing production, the Fed may have more urgency to intervene. Non-farm

payrolls remain resilient, which points to the fact that the US is not on the brink of a recession. It remains key that core

goods inflation remains stable around 3% to give room to the Fed to cut rates. It’s becoming clear that a trade war has

negative consequences for US growth and core inflation.

To make matters worse, Trump resumed the trade war with China with both superpowers launching into another round

of tariffs. China unexpectedly retaliated by imposing import tariffs on US$75billion of US goods. In addition, the Chinese

have to deal with civil disobedience in Hong Kong. This fanned up fears that the fragile global economy may dip further

as a lethal cocktail of central bank dilly-dallying and a trade war dents business confidence further. Commodity prices

took a dive with key iron ore benchmark prices plunging some 20% in a matter of weeks and the key industrial metal,

copper, hitting two-year lows. The key global manufacturing indices have dived and are at five-year lows.

A global downturn is igniting fear in global investors with approximately US$14 trillion of negative-yielding bonds

globally. Simply put, investors will get less than their initial capital at maturity. These make up a quarter of the Barclays

Global Aggregate Index of investment-grade bonds. There is still so much fear of an economic collapse that investors

in the developed world are willing to pay a premium to hide their money in government bonds, knowing that they will

incur a loss. But it’s not bad news for everyone – many sovereigns have been able to issue 100-year bonds at rates of

close to 1%! This is why there is increasing talk of the ‘Japanification’ of the global economy since the Bank of Japan

introduced negative rates 20 years ago.

On the equity front the listing of US companies which are loss-making has been raising eyebrows with a record 81% of

initial public offerings (IPOs) last year being those of loss-making companies – beating the 68% of loss-making

companies which listed during the dotcom bubble. Uber, which listed recently, was the IPO of a company with the

largest losses and WeWork, which listed in September, was the company with the second-largest level of pre-IPO

losses on record. For interest’s sake, the third-largest listing belongs to Lyft, highlighting an unhealthy appetite by

investors for companies that have unprofitable business models. But the listing of much-celebrated Silicon Valley 15-

year veteran Palantir Technologies has been postponed to 2022, indicating that market appetite for unprofitable

companies seeking to list is waning.

Chinese GDP growth slowed to 6.2%, lower than the levels of the global financial crisis as the impact of the economic

rebalancing and the trade tensions take their toll. Food inflation is coming through but underlying inflation is turning

down as imports are in deflation. Chinese manufacturing growth has slowed from 10% to close to zero. The

government has also reined in the shadow banking sector but it remains high with credit at over 200% of GDP and non-

performing loans remain stubbornly high.

In the UK, Eurosceptic Boris Johnson has become the prime minister after being elected as leader of the Tories. There

appears a greater likelihood of a no-deal Brexit or, at the very least, yet another postponement of the October decision

deadline.

16

The market has discounted this in large part with a weaker Sterling. As business decisions get postponed, the UK

should dip into a technical recession. The drone attack in Saudi Arabia in September led to the largest intraday spike

in the oil price on record with some 5% of global oil supply impacted. This came soon after US and Iranian

skirmishes in the Strait of Hormuz, through which a third of global seaborne crude passes.

South Africa – In a debt spiralThe quarter was dominated by the major slippage on the fiscal side with the R59 billion government support for

Eskom adding to a widening budget deficit and concerns that the debt-to-GDP ratio will prove increasingly difficult to

stabilise. While reaffirming the SA sovereign rating at BB+, Fitch nonetheless revised the outlook from stable to

negative at the end of July. Finance Minister Tito Mboweni has tabled some proposals to drive economic growth,

given that it’s a burning platform.

We expect some deterioration with the fiscal deficit having already slipped from 4.7% to 5.7%. While the global

picture has been supportive and flows have kept yields artificially high, income growth in SA is the weakest since the

1970s. Inflation is also on a downward trend towards 4% p.a. with lower oil and food inflation offsetting double-digit

increases in some administered prices. The debt-to-GDP ratio is at risk of passing the 50% mark with additional

support for Eskom up to R50 billion this year and even higher next year. The primary budget balance is deteriorating

to -2%, which is the worst position in five years and will not stabilise the debt-to-GDP ratio. Treasury managed to

issue expensive Dollar debt at the end of the quarter. Revenue collection is 3% behind budget with corporate taxes

slugging and VAT collection actually down. Unemployment has also spiked to 21% from 20% over the past decade.

Moody’s may well move us to negative watch by November if these trends continue.

After one of its longest downcycles since 1945 with some 67 months of decline, we keep looking for some green

shoots in the local economy. That said, the rebound in GDP growth of 0.9% year-on-year in the second quarter was

unexpected. We desperately need the rebound to continue over the next two quarters in the face of low business

confidence for 70% of businesses, in order to post GDP growth of around 0.7% for the year. Production is not

improving with the August ABSA Manufacturing PMI in August and other leading indicators still pointing downwards.

JSEThe beginning of the year has seen foreigners sell over US$5 billion of equities and bonds as economic growth

remains moribund and rating agencies claw at our doors. The political situation also remains tenuous with the so-

called ‘fight-back’ faction in the ruling party and the Public Protector’s findings against the president and the minister

of public enterprises distracting government from urgent economic matters. Given this backdrop, the Rand has

weakened and the JSE suffered some losses with the FTSE/JSE Shareholder Weighted Index (SWIX) down 4.3%

this quarter, which aggregates to a zero return over the past year.

The earnings season saw a strong showing by the miners. Despite strong results, we saw Indian billionaire Anil

Agarwal and Anglo American’s biggest shareholder place his 2% holding in the market at a 4% discount. While this

took the market by surprise, this was offset by the unexpected announcement that Anglo would undertake a US$1

billion share buyback (2.7% of market cap). Sasol’s woes continued with the delay in releasing its financial results

mid-August leading the share to dive 16% on the day. The market remains uncertain as to the debt burden

accumulated by the company following cost overruns at its Lake Charles operations in the US.

The results season was dominated by the change in lease accounting caused by IFRS 16, which has the effect that

leases amortised over the term of the debt and the present value of the leases are treated as debt.

The Independent Communications Authority of SA (ICASA) will be implementing the long-awaited new spectrum

framework over the next year. Broadly it is negative for Telkom and pricing will be under pressure, but good for the

industry in the long term as capacity gets increased. The industry will have to pay for the extra spectrum with the

benefits accruing in the long term.

The National Health Insurance (NHI) Bill was proposed, which will make the state the sole purchaser of all

healthcare services effectively displacing medical aid schemes and broadening access to healthcare to a larger

portion of the population.

Government spends 4.5% of GDP on healthcare with 40% of healthcare spend derived from private medical aids

(R200 billion). Therefore, to make up that shortfall, government will have to increase taxes and eliminate the R27

billion medical aid tax credit.

In an attempt to unlock value, Naspers listed its offshore assets under the name Prosus on the Euronext stock

exchange in Amsterdam during the last week of September. While the group will retain at least 73% of the assets the

aim is to:

• Attract fresh shareholders in Europe where there is a dearth of technology assets (as opposed to the US or Asia)

17

• Provide greater visibility as to the valuation of the unlisted internet assets

• The absolute weight of Naspers will drop to 19% in the SWIX index, while Prosus will be a new inward-listed

entity with a 3.4% weight in the index.

The risk, however, remains that Naspers will continue to trade at a large discount to its underlying assets – even

though Prosus will have a listed price.

Offshore diversification has been no panacea either. The UK has been especially problematic with companies

like Famous Brands, Brait and Rebosis having to count the cost of their expansions. Standard Bank is trying to

offload its London operations to ICBC and Old Mutual eventually came back to home base. Speaking about Old

Mutual, the spat between the board and its CEO, Peter Moyo, took an unexpected turn when the courts initially

ruled that the CEO should be reinstated only for the company to challenge the judgement and fire the CEO a

second time. The share came under severe pressure as the market struggled with the leadership vacuum.

The most surprising piece of news flow this quarter is the offer from PepsiCo to buy Pioneer Foods at a hefty

premium. If one adds the buyout of Clover, the depressed local valuations of SA-focused stocks are certainly

attracting opportunistic bidders. But industrial bellwether Shoprite didn’t fare as well, dropping 16% in the week

following dismal results where poor volumes from South Africa were matched by losses in the rest of Africa as a

cocktail of weak local currencies and Dollar-denominated debt conspired to drain cash flows from the group.

Portfolio performanceThe Moderate Equity house view portfolio slightly outperformed by 52 basis points (bps) this quarter and the

performance year to date remains strong with the portfolio beating its benchmark by over 200 bps. The SWIX

index had a tough quarter, down 4.3%. Industrial stocks were down 2.5%, which was better than the index. The

largest 15 financial stocks were down a hefty 7.7% as the Rand weakened and resources stocks were down

some 6.4%.

Our largest position, Naspers, unlocked some value with the listing of its offshore internet holdings in

Amsterdam. This follows a successful listing of its MultiChoice assets as management takes action to unlock

value. Our overweight position in British American Tobacco added to performance, up 14% this quarter. The

market is now coming to grips with the fact that competitors selling vaping products in the US are likely to be

subject to strict regulation.

The overweight position in selected resources stocks continues to be supportive given the positive Chinese

growth picture, strong commodity prices and weak Rand. Our overweight position in Impala Platinum, up 37%

this quarter and 246% over the past year, is illustrative of how a contrarian position accumulated over the past

few years, when extreme pessimism prevailed and most investors liquidated their positions at almost any price,

can pay off. Our other key overweight position, Sibanye Gold (+25%), was buoyed by strong precious metal

prices. However, a delay in the release of its financial results meant that Sasol was down another 28%, after

declining 22% the previous quarter.

On the financial side, we continue to retain an underweight position in the more expensive stocks such as

Capitec, which was down 1%. The public spat between Old Mutual, an overweight counter, and its CEO weighed

down on the stock, which was down 6.8%.

ConclusionIn an era of big data, we have created a technology platform which collates data from multiple sources and is

validated by our analysts. Data are then interpreted and interrogated in order to draw insights with a view to

identifying the most undervalued and overvalued companies based on a number of scenarios. We have also

incorporated a number of environmental, social and governance (ESG) considerations in our process to gain

deeper insights into our companies. While there are a lot of headlines about how machines will replace human

beings in a number of professions, our research shows that stock markets are driven both by fundamentals and

emotions and that it is important that raw data collated by our systems are correctly interrogated and interpreted

by our analysts in order for the correct investment decisions to be made. As an active manager, we have the

unique advantage of being able to put together portfolios with the appropriate expected returns to meet your

investment objective. And, at the end of the day, the outperformance of our funds over the past decade is the

clearest testimony that our continuously evolving process involving both man and machine remains very

effective in delivering on your long-term investment goals.

18

BondsBy Mokgatla Madisha

Head of Fixed Income

Sanlam Investments

The hunt for yield

gains momentum

Developed market bond yields continued to trend

lower. Yields on the benchmark US 10-year bond

declined 34 basis points (bps) from 2% at the end

of June to 1.66%. In Europe, the yield on the

German 10-year Bund touched a new all-time low

of -0.716%. The difference between the US 2-

year and 10-year bond collapsed 20 bps and

briefly inverted, before the curve re-steepened.

However, the inversion between the 10-year bond

yield and the US Federal Reserve (Fed) overnight

rate has persisted since mid-May. An inverted

yield curve has preceded every recession in the

US over the past 50 years.

Despite rate cuts and the subsequent fall in bond

yields, US rates remain the highest among G10

countries. A combination of better growth and

higher yields relative to the peers led to a stronger

Dollar, which gained 3.4% on a trade-weighted

basis.

Globally the stock of negative-yielding debt

touched new highs at $17 trillion, however, with

the sell-off in September negative-yielding debt

declined to about $14 trillion.

On 17 September the Fed’s secured overnight

financing rate (repo rate) touched 10% intraday.

The repo rate is the rate at which the primary

dealers finance long positions. Under normal

market conditions this rate should trade at similar

levels to the effective federal funds rate. The

dislocation that occurred in September was

blamed on quarterly tax payments and settlement

of a large T-bill auction. The Fed responded by

injecting up to $75 billion of liquidity, the first time

if has done so since the credit crises. The Fed

also announced that this liquidity facility will be

available until 4 November.

Local market review

In July, the finance minister announced plans to

increase support for Eskom by an additional

R59 billion over the next two years. An allocation of

R26 billion was made for the current year in addition

to the R23 billion announced in the February budget.

The increased support for state-owned companies

(SOCs) and lower revenue collection by the South

African Revenue Service increased the funding

requirement for National Treasury. Weekly nominal

bond auctions were increased to R4.53 billion from

R3.3 billion, while the inflation-linked bond auction

volume increased to R1.07 billion from R0.67 billion.

Prior to the increased issuance announcements

bond yields had traded to 14-month lows. The

benchmark R186 traded to 7.97% before selling off

to 8.47%. The yield curve shape did not react much

to the increased bond supply, however, the flattening

that would have been expected as bond yields

moved higher did not happen. Fitch changed South

Africa’s rating outlook from stable to negative due to

the increased support for Eskom, while Moody’s also

said the move was credit-negative.

The FTSE/JSE All Bond Index returned 0.78% for

the quarter, underperforming the STeFI cash index

return of 1.83%. The three- to seven-year sector

delivered the best return ending the quarter at

1.29%. The yield on the benchmark R186 rose

0.235% to 8.32% while the R2035 (16-year bond)

yield rose 0.17% to 9.61%.

With inflation remaining relatively subdued, demand

for inflation protection has been week. The inflation-

linked index returned just 0.25% for the quarter.

Yields on the I2029 (10-year bond) rose 0.24% from

3.17% to 3.41%. The yield on the ultra-long I2050

reached a new high of 3.65% in September before

ending the quarter at 3.63%. Credit spreads

continued to tighten even as fundamentals have

deteriorated.

19

While we do not expect an eminent reversal of the

trend, we have noticed that auctions are starting

to price within price guidance, rather than below,

and market orders to sell are getting longer. We

used the opportunity to selectively reduce

exposure.

Bond market outlook

Contrary to our expectations, local factors were

the main determinates of performance over the

past three months, particularly revenue shortfall

and bailouts of SOCs, which pushed projected

fiscal deficits for 2019/20 to about 6%. As we

head into the Medium-Term Budget Policy

Statement the market will fret about National

Treasury’s ability to get spending under control.

Failure to show a credible fiscal consolidation path

will result in heightened rating down-grade risk. The

underperformance of South African bonds relative to

emerging market peers has resulted in attractive

valuations and this should support the market in any

sell-off.

In developed markets we think the Fed will continue

to ease monetary policy to support growth in the

face of continuing tensions and slowing growth.

Locally we do not expect the South African Reserve

Bank to cut the repo rate in the remaining meeting

this year.

We continue to favour nominal bonds over inflation-

linked bonds and credit.

20

Smoothed BonusPortfolios

Product RangeStable Bonus Portfolio

The Stable Bonus Portfolio (SBP) offers investors

stable, smoothed returns with a partial guarantee on

benefit payments. A bonus, which consists of a vesting

and non-vesting component is declared monthly in

advance. Bonuses cannot be negative.

Monthly Bonus Fund

The Monthly Bonus Fund (MBF) protects investors

against short-term volatility by smoothing out

investment returns, while providing valuable guarantees

on benefit payments. Fully vesting bonuses are

declared monthly in advance. Bonuses cannot be

negative.

SMM Vesting Fund

The SMM Vesting Fund is a multi-managed smoothed

bonus fund, which provides exposure to leading

investment managers. Investors are protected against

short-term volatility by smoothing out investment

returns, whilst providing guarantees on benefit

payments. Fully vesting bonuses are declared monthly

in advance. Bonuses cannot be negative.

Sanlam Absolute Return Plus Fund

Sanlam Absolute Return Plus Fund provides risk-

averse members with exposure to Sanlam’s Inflation

Linked Fund with a capital guarantee. This is achieved

through extensive use of derivative (hedging)

instruments and the declaration of a monthly fully

vesting bonus. Bonuses cannot be negative. At

termination, the full value of net contributions plus

declared bonuses are paid.

Members benefit from the underlying portfolios’

investment returns through regular bonus declarations.

These regular bonuses are designed to provide a

smoothed return to members over time. This reduces

the volatility of investment returns (i.e. extreme ups and

downs in the market) relative to an investment in

market-linked portfolios.

During periods of strong investment performance, a

portion of the underlying investment return is held back

in reserve and is not declared as a bonus. This reserve

is then used to declare higher bonuses during periods

of lower return than would otherwise have been the

case.

The benefits of smoothing include:

• Reducing the exposure to short-term market

volatility.

• Lessening the risk of investing in or disinvesting

from the market at the wrong time due to

circumstancesbeyond a member’s control.

It is important to note that smoothing merely changes

the timing of when investment returns are released and

does not reduce or increase the returns. Over time, the

bonuses should produce a similar return to the

underlying investment in the fund (after deduction of the

guarantee costs).

Smoothing terminology

Book value

The book value is the net contributions accumulated at

the bonus rate declared.

Market value

The market value is the amount obtainable on the open

market by the sale of the underlying assets.

Funding level

The products’ funding level is the ratio of market value

to book value. This is used in the bonus declaration

formula.

Bonus

A monthly increase to a client’s book value, expressed

as a percentage. Bonuses are declared before the start

of the month to which they apply, and are allocated at

the end of the month.

Benefit payments

The book value is paid on death, disability, resignation,

retrenchment or retirement. There is no limit on the

amount of benefit payments at book value. Other exits,

such as termination or investment switches will occur at

the lower of book and market value.

21

Fees

Guarantee fee

Investment administration fees

Monthly Bonus Fund and Stable Bonus Portfolio

The investment manager may be incentivised with performance fees (capped at 0.3% p.a.).

Details of the performance fees actually paid over the past calendar year are available on request.

Portfolio Guarantee fee

Monthly Bonus Fund & SMM Vesting Fund 1.60%

Stable Bonus Portfolio 0.90%

Portfolio Guarantee fee

SMM Vesting 0.55%

Sanlam Absolute Return Plus 1.00%

Size of investment Fee

Less than R100m 0.425%

R100m to R300m 0.375%

R300m plus 0.325%

22

Productinformation

Portfolio July-19 Aug-19 Sep-19

Periods to 30 September 2019

(annualised)

1 year 3 years 5 years

Smoothed Bonus Partially Vesting

Sanlam Stable Bonus Portfolio 0.644% 0.566% 0.560% 6.84% 7.66% 8.94%

Smoothed Bonus Fully Vesting

Monthly Bonus Fund 0.586% 0.508% 0.498% 6.16% 7.04% 8.46%

SMM Vesting 0.572% 0.504% 0.429% 4.49% 6.23% 7.77%

Derivative Based Fully Vesting

Sanlam Absolute Return Plus 1.260% 0.210% 0.700% 7.31% 8.46% 9.04%

Inflation 0.36% 0.27% 0.27% 4.13% 4.70% 4.96%

Performance: Bonuses % (Gross of fees)

23

% of fund

Stable Bonus Portfolio Monthly Bonus Fund SMM Vesting

Naspers 4.1 Naspers 4.2 Naspers 3.5

FirstRand 1.6 FirstRand 1.6 Prosus 1.3

British American Tobacco 1.5 British American Tobacco 1.5 British American Tobacco 1.3

Standard Bank Group 1.4 Standard Bank Group 1.4 FirstRand 1.2

Prosus 1.3 Prosus 1.3 Anglo American 1.2

Anglo American 1.2 Anglo American 1.2 Standard Bank Group 1.2

MTN Group 1.1 MTN Group 1.1 Impala Platinum Holdings 1.1

Sasol 1.0 Sasol 1.0 MTN Group 0.6

Consol Holdings 0.8 Consol Holdings 0.8 Sasol 0.6

Impala Platinum Holdings 0.8 Impala Platinum Holdings 0.8 Bid Corporation 0.6

Top ten equity holdings as at 30 September 2019

Cash3%

Bonds20%

Credit5%

Inflation-linked

4%

Property7%

Equities33%

Foreign28%

Cash3%

Bonds20%

Credit5%

Inflation-linked

4%

Property7%

Equities33%

Foreign28%

Cash6%

Bonds31%

Property6%Equities

28%

Private Equity

1%

Foreign28%

Bonds10%

Inflation-linked

1%

Money Market51%

Property1%

Equities18%

Foreign19%

Stable Bonus Portfolio Monthly Bonus Fund

SMM Vesting Sanlam Absolute Return Plus

24

The SanlamProgressiveSmoothBonus Fund

The Sanlam ProgressiveSmooth Bonus Fund is aworld first, black managed,smoothed bonus product.Thismulti-manager, diversifiedinvestment portfolio offersprotection againstshortterm market volatility and aguaranteed return over thelonger term. The ProgressiveSmooth Bonus Fund ismanaged by 27four InvestmentManagers and is guaranteed bySanlam.

How ItWorksThe Progressive Smooth Bonus Fund

works to smooth volatile investment

returns by declaring guaranteed

monthly bonuses. These monthly

bonuses reduce the rollercoaster ride

that investors experience in market-

linked portfolios, ensuring a much

smoother return profile. Suchfunds have

performed particularly well for investors

in the volatile and uncertain global

economic context brought on by the

2008 financial crisis.

25

Fund BenefitsThe fund is a ‘win-win’ solution that’s

well suited for progressive retirement

funds that see the transformation of

the financial services industry as a

national priority, and retirement fund

members that value the benefit of

smoothed returns. By supporting and

allocating funds to black asset

managers, the Sanlam Progressive

Smooth Bonus Fund provides these

managers with a platform to compete

against stablished managers in the

industry in order to transform the

profile of the South African

investment management landscape.

We aim to invest with managers

meeting the following criteria:

• Greater than 50% effective black

(South African) ownership with

equivalent voting rights;

• Greater than 50% black (South

African) board members; and

• Greater than 50% black

(South African) investment

professionals.

Product Information:30 September 2019

Gross Bonuses(%)

Enjoy the benefits of asmooth investmentreturn:• Stable monthly bonuses

• Market-related performance

• Guarantees on benefit payments (resignation,

retirement, retrenchment, disability and death)

• Peace of mind irrespective of marketconditions.

Gross Bonus* CPI Inflation

1 month 0.5% 0.3%

3 months 1.9% 0.9%

6 months 3.8% 2.2%

1 year 6.2% 4.1%

* Gross bonuses net of guarantee fee, gross of investment fee

26

AssetComposition

Top 10Holdings

ManagerSelection

Cash9%

Bonds24%

Property7%

Equities36%

Foreign24%

Asset Class Managers

RSA EquityKagiso, Sentio, Benguela,

Aeon, Aluwani

RSA Bonds Argon

RSA Property Sesfikile

RSA Cash Prowess

International Equity 27four

International Property Sesfikile

% of Equity

Naspers 4.9

Standard Bank 2.1

Prosus 1.8

British American Tobacco 1.7

Anglo American 1.6

MTN Group 1.2

Mondi 1.1

FirstRand 1.1

Sasol 1.0

Northam Platinum 0.9

27

Record of Proxy VotingIn terms of the mandate you have given us, we vote your shares according to SIM’s Proxy Voting guidelines. A

full record of the “Against” votes cast by SIM is shown below. A complete record of all votes cast on your

shares is available on request.

28

Record of Proxy Voting

29

Record of Proxy Voting

30

Record of Proxy Voting

31

Record of Proxy Voting

32

Record of Proxy Voting

33

Governance Structure

Asset & Liability CommitteeSanlam’s Asset Liability Committee (ALCO)

provides a strategic framework for the

management of Sanlam’s Smoothed Bonus

business. This includes determining the strategic

asset allocation and the setting of benchmarks and

risk parameters for Sanlam Investment

Management (SIM).

A sound governance structure is needed to manage discretionary participation business, which forms a

substantial proportion of Sanlam Life’s liabilities. The Sanlam Life Insurance Limited Board (“Sanlam

Life Board”) is ultimately responsible for the governance of discretionary participation business, but a

number of parties assist in this regard, including:

• the Board’s Audit, Actuarial and Risk Committee;

• the Board's Policyholders' Interest Committee;

• the Asset Liability Committee (ALCO);

• the Statutory Actuary; and

• the external auditors and their actuarial resources

Directive 147.A.i (LT) issued by the Financial Services Board requires insurers to define, and make

publicly available, the Principles and Practices of Financial Management (PPFM) that are applied in the

management of their discretionary participation funds.

The Sanlam Life Board has tasked its Policyholders’ Interest Committee to monitor compliance with the

PPFM on its behalf. The PPFM may change as the economic or business environment changes. Any

change to a Principle or Practice will be approved by the Sanlam Life Board, on recommendation from

the Statutory Actuary and the Policyholders’ Interest Committee.

The Asset-liability committee (ALCO), comprising Sanlam Life employees with actuarial, investment and

client solution backgrounds, oversees the investment policy for the various smoothed bonus portfolios.

AuthorityThe ALCO is mandated by the Sanlam Life Board

to oversee the investment management of the

portfolios mentioned within the Approval

Framework of Sanlam Personal Finance and

Sanlam Employee Benefits. It is a management

committee which reports on its deliberations and

activities to the Policyholders’ Interest as well as

the Audit, Actuarial and Risk committees of the

Sanlam Life Board.

34

Responsibilities for investment decisionThe role of ALCO is inter alia to:

• Find an appropriate balance between competitive investment returns and an acceptable degree of risk given

the nature of the policy liabilities.

• Establish, monitor and update investment parameters outlined in Investment Guidelines that reflect the

objectives of the funds under consideration.

• Assess the Sanlam Group’s ability to meet its empowerment financing targets in terms of the Financial Sector

Charter.

• Balance the interests of shareholders and policyholders with regard to the relevant portfolios.

• Obtain feedback and reporting on markets, investment actions undertaken and the performance and

attribution of the underlying funds.

• Ensure compliance with legislation and policyholder reasonable benefit expectations.

• Debate potential new types of investment opportunities that may further optimize the portfolios’ risk return

profile.

CompositionThe ALCO is a joint forum on which executives from Sanlam Life and SIM are represented. The Committee

comprises of:

• Statutory Actuary (chairman)

• Chief Executive: Actuarial

• Other representatives of Sanlam Life:

− Sanlam Personal Finance Client Solutions

− Sanlam Structured Solutions

− Actuarial

− Risk Management

• Head: Asset Liability Solutions of SIM

• Other representatives of SIM

Responsibility for investment decisions

Decision Responsibility

Strategic asset allocation ALCO

Benchmarks per asset class ALCO

Tactical asset allocation SIM

Stock selection SIM

Risk parameters ALCO

35

Financial Strength

Sanlam Employee Benefits is part of Sanlam Life, a South African insurance giant. Our

policies are backed by the considerable financial strength of Sanlam Life, providing

security and peace of mind.

The capital levels of Sanlam Life are shown below:

31 December 2018

Solvency Capital Requirement (SCR): 221%

Sanlam Life has a Standard & Poor’s (S&P) credit rating of zaAAA.

36

SmoothedBonus –Roles

Rhoderic NelBCom Certificate in Finance & Investments

CEO SEB Investments

Sanlam Employee Benefits: Investments

Danie vanZylB.Com (Hons), FIA, FASSA

Head: Guaranteed Investments

Sanlam Employee Benefits: Investments

Samantha NaidooActuarial Specialist

Sanlam Employee Benefits:

Investments

Bethuel KoraseActuarial Specialist

Sanlam Employee Benefits: Investments

Lorraine LoubserAssistant: Guaranteed Investments

Sanlam Employee Benefits: Investments

Susan GeorgeContracts

Sanlam Employee Benefits: Investments

37

38

FurtherInformation

Visit our website at:

http://sanl.am/sebi

Protection-focused Solutions

Structured investmentsand retirement fund solutions for a comfortable retirement.

Our guaranteed investments provide retirement fund memberswith smoothed, real returns and capital

protection to protect and grow retirement savings. The portfolios offer full or partial guarantees on benefit

payments for death, disability, resignation, retrenchment and retirement. Bespoke asset liability matching or

liability- driven investment solutions cater for both pre- and post-retirement liabilities. Our annuities provide

guaranteed, regular income for life.

SmoothedBonusPortfoliosProtect your investment

from short-term downturns

andvolatility through

monthly bonuses that that

are designed to providea

smooth return.

More

AnnuitiesReceive a regularincome

throughout retirement for

peace of mind. You can

choose to increase your

income by a level

percentage, or an increase

linked toe either inflation or

underlying investment

portfolio’s growth.

Asset-LiabilityMatchingSolutionsMatch liabilities by investing in

assete that move in linewith

the liabilities, taking into

account future

required increases. The full

range of liability- driven

investment strategies caters for

each client’s specific risk-return

objectives, making use of

different enhancing strategies for

outperformance.

Lifestage SolutionGrow your retirement savings by investing in a solution that

automatically switches you into appropriate risk- return

portfolios throughout your life.

Post-Retirement MedicalAid (PRMA)SolutionsThis is a comprehensive solution, wich could

entail removing the liability from the balanced

sheet, or setting up a plan asset or various

funding solutions funded via an asset liability

matchingstrategy.

More More

More More

call usAny queries may be mailed to:Sanlam Employee Benefits: Investments

Private Bag X8

Tyger Valley

7536

Call us at: (021)950-2500

If you have any recommendations to enhance this

document, please write to the above address.

Any queries regarding legal compliance issues should be made

in writing and addressed to:

The Compliance Officer

Sanlam Employee Benefits

PO Box 1

Sanlamhof

7532

South Africa

Disclaimer

Sanlam Life Insurance Ltd is an authorised financial services provider.

This survey is for the use of Sanlam and its clients only and may not be published externally

without permission first obtained from Sanlam. While all reasonable attempts are made to

ensure the accuracy of the information, neither Sanlam nor any of its subsidiaries makes any

express or implied warranty as to the accuracy of the information. Past performance is not

necessarily a guide to future returns. Investment returns can be positive or negative. The

material is meant to provide general information only and not intended to constitute

accounting, tax, investment, legal or other professional advice or services. This information

should not be acted on without first obtaining appropriate professional advice. The use of this

document and the information it contains is at your own risk and neither Sanlam nor any of its

subsidiaries shall be responsible or liable for any loss, damage (direct or indirect) or expense

of any nature whatsoever and howsoever arising.

T +27 (0)21 9479111

F +27 (0)21 947 8066

www.sanlam.co.za

2 Strand Road, Bellville, Cape Town | PO Box 1, Sanlamhof 7532, SouthAfrica

Sanlam Life Insurance Limited Reg no 1998/021121/06.

Licensed Financial Services Provider.