CELEBRATING
Capital International Group
YEARS IN BUSINESS
THIRD QUARTER 2016
INVESTMENT REVIEW INNOVATION | INTEGRITY | EXCELLENCE
Our Vision The Capital International Group exists to improve lifestyles through increased prosperity Our Values We seek to achieve this through the enduring values of innovation, integrity and excellence
Central Banks continued to dominate the markets, although volatility was very low over the summer...
Investment Review Contents Global Equities More of the same...
Celebrating Top Award Page 2
FRIDAY | 23 SEPTEMBER 2016 The latest quarter has probably been a surprising one for investors in global equities, in that positive returns have been in abundance for a Sterling based investor...
Currency in Focus Sterling
Page 4
MONDAY | 25 JULY 2016 The aftermath of the UK referendum saw sterling fall by around 11% against the US Dollar (a 31-year low) and by around 9% versus the Euro as investors reassessed...
Country in Focus China
Page 6
THURSDAY | 28 JULY 2016 With the headlines in the UK of Brexit, we have recently been through one of those phases where words simply drop from the headlines and China has been very quiet in recent months...
Economy in Focus Ireland & Taxation
Page 8
FRIDAY | 30 SEPTEMBER 2016 The Irish economy is set to register significant growth in 2016 following exceptionally strong performances in 2015 & 2014...
Country in Focus Australia
Page 10
WEDNESDAY | 31 AUGUST 2016 After over 20 years of continuous growth, low unemployment, low public debt, contained inflation and a stable and strong financial system...
Economy in Focus UK | Post-Referendum
Page 12
WEDNESDAY | 31 AUGUST 2016 At its latest monetary policy committee meeting, the Bank of England cut its headline interest rate to 0.25% from 0.5%...
Fixed Income Report Third Quarter Update
Page 14
FRIDAY | 30 SEPTEMBER 2016 It has been yet another fascinating period for the global bond market as QE and an interest rate cut occurred in the UK...
Celebrating 20 Years in Business Page 16
August 2016 marked an important milestone for the Capital International Group as we look back on our extraordinary heritage of talent and achievements over the last twenty years. © Capital International Group 2016
Volume: 14 | Issue: 3
Page 18 Capital Treasury Services is celebrating the Capital Liquidity Account being awarded the AAAf/S1+ rating by Standards & Poor’s for the tenth consecutive year...
Industry in Focus UK Oil Sector
Page 20
WEDNESDAY | 07 SEPTEMBER 2016 The hangover of crude oil’s sharp falls in recent years has been evident in the historically low levels of new oil that is currently being discovered...
The State of the World Post-Brexit
Page 22
WEDNESDAY | 06 JULY 2016 2016 has been a tough year for bank stocks globally as they continue to deal with the fallout from legacy issues whilst facing a period of introspection regarding their future business models...
News in Focus South Africa Update
Page 26
MONDAY | 26 SEPTEMBER 2016 Undoubtedly the major event in third quarter was the Municipal elections held on 3 August...
Market in Focus Global IPOs
Page 28
WEDNESDAY | 14 SEPTEMBER 2016 Global IPO proceeds thus far in 2016 are running at just below $50 billion, this is way below the average experienced...
Country in Focus South Africa
Page 30
MONDAY | 19 SEPTEMBER 2016 Factors affecting South Africa like the recent Political infighting, paralysis and dragging feet with the urgent and much needed transformation of SA parastatals...
Industry in Focus Global Agriculture
Page 32
FRIDAY | 23 SEPTEMBER 2016 According to the UN’s Food and Agriculture price index, general food prices rose to their highest level in 15 months in August, recording a jump of around 7% in the August to August period...
Group News Activities, Appointments & Events
Page 34
Global Equities
More of the same... FRIDAY | 23 SEPTEMBER 2016
The latest quarter has probably been a surprising one for investors in global equities, in that positive returns have been in abundance for a Sterling based investor. The EU Referendum sent the currency down sharply (currently down 12.5% since the vote) which will probably lead to higher inflation levels in due course. The Bank of England were so concerned by the prospect of a recession, that they cut interest rates in early August to 0.25%. With further Quantative Easing, the Central Banks continue to dominate the markets, although volatility was very low over the summer months. UK economic growth will be around 1.6% in the current year, falling to zero for 2017. The main problem is that it is still totally unclear when Article 50 will be invoked and so people are trying to act ‘normal’. There must be spill over effects and we continue to hear that capital expenditure is muted, not to mention the property sector impact. The FTSE 100 index is a global one and Blue Chips have performed well, combined with the desperate search for yield. Broadly, US equities have continued to perform well, although the large proportion of the gains in the last quarter came from the technology sector. If we exclude consumption, US GDP growth is actually negative and every time this has happened since 1945 there has been a recession. Productivity growth remains a major challenge with readings consistently less than 1%. Equity ratings are high and margins are under pressure. We have made no secret that we have reduced exposure to the region. Continental Europe has continued to see the economic recovery (1.5% for 2017) on track but it has certainly lost momentum in the wake of both the Brexit vote and also future political challenges. German industrial production has struggled and deflation across the region remains a real issue. However, relative to the US, GDP growth is faster and so domestic growth stocks still look attractive. Some of the cyclical stocks have already performed well and we would caution chasing them. Global investors should also experience somewhat of a yield pick-up. Japan has produced better returns this period, again driven by the Central Bank and the prospect of widened Quantative Easing, although possibly no imminent increase in the negative interest rate. Authorities still need to get inflation going and are targeting banks to boost levels of lending. There have been more positive signs in the capital goods sector. The last few months have seen a mini re-acceleration in the Chinese economy as the State spending was front end loaded for the year. Indeed, the government deficit has grown to 4%. The housing sector is also supportive with decent prices rises and low inventory levels. GDP growth in 2017 should therefore hit between 6-6.5%. Both retail and car sales are rising at very healthy levels, close to 10% which also bodes well.
2
In the US, the S&P 500 index has risen 3.7%, whilst the Dow Jones is up 2.5% but the star is the NASDAQ which is up over 10% on the quarter. Positive technology stocks have included Seagate up 50% as storage and big data becomes a pressing long term issue. Other gainers included eBay up 38%, Micron Technology up 28% and Teradata up 22%. Energy also continued to bounce with Chesapeake Energy up 60% and Devon Energy up 16%. Concern over State subsidies led to falls in some of the solar energy stocks, notably First Solar down 27%. Other fallers included Campbell Soup down 17%, Dollar Tree lost 15% and Whole Foods declined nearly 11%. In the UK, the FTSE 100 has gained 6%, whilst the FTSE 250 has rallied nearly 10% after being hit hard in the immediate aftermath of the Brexit vote. Interestingly the smaller company, AIM index was up 15%, to now stand at similar year to date gains as the Blue Chips. Miners were back in vogue as China appeared to stabilise, Ferrexpo stood out climbing 150%, whilst Hochschild Mining was up 58% and Vedanta was up 33%. Other gainers included Metro Bank up 53%, Galliford Try up 44% and Wetherspoon up 33%. There was weakness in some of the oil stocks with Tullow Oil down 12% and Cairn Energy losing 10%. Other notable fallers included Pearson down 21% on US trading fears and CMC Markets also down 21% on the lack of volatility impacting trading volumes. Continental European markets were robust with France up 5.75%, the German DAX rose nearly 10% and Spain was up 7.75%. The only real area of weakness remained Italy which only rose 1.5%, as the troubles of the Financial sector continued to overshadow the economy. Gainers over the period included the fashion website, Yoox, which was up 38%, Credit Suisse was up 26% and Peugeot rallied 25%. On the negative front, Ingenico dropped 24% as the payments processor struggled in Brazil and with a new type of US credit card. Other losers included Sanofi down 9% and ENI down 14%. Asian equity markets completed the strong picture for the quarter with Japan rallying 8%, India was up 6%, and Hong Kong gained nearly 14%, whilst China lagged to some extent only up 3%. Nintendo was a star performer up 86% with the launch of Pokémon Go. Other risers included Brother Industries up 60%, Nippon Paint was up 38% and Korean Air Lines climbed 31%. Amongst the losers, Noble Corp fell over 30% on trading losses with Ryohin Keikaku down 19% and HTC Corp was also down 19%. World Indices UK Markets Dow Jones NASDAQ S&P 500 DAX CAC 40 Nikkei 225 Hang Seng FT All Gilts
Price at 30-Sep-16 30-Jun-16 30-Sep-15 6,899.33 18,308.15 5,312.00 2,168.27 10,511.02 4,448.26 16,449.84 23,297.15 190.00
6,504.33 17,929.99 4,842.67 2,098.86 9,660.44 4,237.48 17,388.15 20,846.30 173.79
6,061.61 16,284.70 4,620.17 1,920.03 9,660.44 4,455.29 17,388.15 20,846.30 173.79
% Chg Quarterly 6.07% 2.11% 9.69% 3.31% 8.80% 4.97% -5.40% 11.76% 9.33%
% Chg 1 Year 13.82% 12.43% 14.97% 12.93% 8.80% -0.16% -5.40% 11.76% 9.33%
eBay
An American multinational corporation and e-commerce company, providing consumer-to-consumer and business-to-consumer sales services via the Internet. It is headquartered in San Jose, California. eBay was founded by Pierre Omidyar in 1995, and became a notable success story of the dot-com bubble. Today it is a multibillion-dollar business with operations localized in over 30 countries..
Teradata
A publicly held international computer company that sells analytic data platforms, analytic products and related services. Its analytics products are meant to consolidate data from different sources and make the data available for analysis. The Teradata product is referred to as a "data warehouse system" and stores and manages data. The corporate headquarters are in Miamisburg, Ohio.
Hochschild Mining
A leading British-based silver and gold mining business operating in North, Central and South America. It is headquartered in London, listed on the London Stock Exchange and is a constituent of the FTSE 250 Index. The company was founded in 1911 and was first listed on the London Stock Exchange in 2006. The main shareholder is the Peruvian businessman Eduardo Hochschild.
Peugeot
Formerly a family business founded in 1810, manufacturing coffee mills and bicycles. Armand Peugeot built the company's first car, an unreliable steam tricycle, in collaboration with Leon Serpollet in 1889; this was followed in 1890 by an internal combustion car with a Panhard-Daimler engine. Due to family discord, Armand Peugeot in 1896 founded the Société des Automobiles Peugeot.
Rates & Commodities GBP/USD GBP/EUR GBP/JPY SILVER GOLD EUR Crude Oil US Fed Funds UK Base Rate ECB Base Rate
Price at 30-Sep-16 30-Jun-16 30-Sep-15 1.2972 1.1543 131.495 19.178 1327.90 47.71 0.50 0.25 0.00
1.3268 1.1982 136.912 18.715 1317.00 48.42 0.50 0.50 0.00
1.5132 1.3533 181.073 14.519 1122.50 47.13 0.25 0.50 0.05
% Chg Quarterly
% Chg 1 Year
-2.23% -3.66% -3.96% 2.47% 0.83% -1.47% 0.00% -50.00% 0.00%
-14.27% -14.70% -27.38% 32.09% 18.30% 1.23% 100.00% -50.00% -
3 © Capital International Group 2016
Currency in Focus Sterling
MONDAY | 25 JULY 2016
The aftermath of the UK referendum saw sterling fall by around 11% against the US Dollar (a 31-year low) and by around 9% versus the euro as investors reassessed the UK’s economic prospects for a future outside of the EU. The magnitude of the intraday falls were even greater as sterling initially strengthened on the incorrect assertion that the referendum result was to remain within the EU before correcting sharply as positions were subsequently reversed. This elevated volatility in the days following the referendum results meant that sterling was briefly one of the world’s most unstable currencies. It has since stabilised at around $1.32 against the US Dollar, however, further falls, according to Reuters, the consensus of banks' forecasts is for the UK currency to fall to $1.28 in three months and $1.265 in six as the uncertainty of an extended period of EU exit talks hurts the economy and the Bank of England looks to ease monetary policy and/or restart a programme of quantitative easing. The swift resolution of the political situation did restore some confidence and allowed the Bank of England to refrain from immediate policy action, prudent given that the timing was too soon to draw any meaningful conclusions, with the data yet to reflect any changes in economic activity/sentiment.
However, a recent Reuter’s poll indicated that economists see an average 60% chance that the British economy will suffer a recession in the coming year. A recent IMF report saw the UK’s growth forecasts sharply downgraded. It is now predicting growth of 1.7% for this year and 1.3% in 2017, citing weakening domestic demand due to increased uncertainty and the lengthy process of negotiating trade deals as key recession risks. As a result, most expect the central bank to act at the next meeting in early August, potentially putting further pressure on the currency. Given that the Bank of England have not partaken in any quantitative easing for a number of years, their balance sheet is relatively small compared to other developed central banks, which leaves them with plenty of ammunition to restart unconventional monetary policy initiatives should they feel the need. One potential hindrance may be the mild resurgence in inflation, with CPI rising by 0.5% in June. Inflation is expected to rise further in coming months as the impact of sterling’s depreciation feeds through into higher import costs. The Bank of England has warned that inflation could temporarily breach the bank’s target of 2%, however, officials have suggested that the central bank would effectively ‘look through’ any Brexit-related price rises caused by the fall in sterling – at least in the short-term. Stock-related ramifications of Sterling weakness have produced both winners and losers. UK-listed companies that derive a significant proportion of their revenues overseas are beneficiaries of Sterling weakness as they receive a translation benefit (overseas earnings are worth more in GBP) as well as a potential boost to competiveness from cheaper exports. In fact, the constituents of the leading UK blue-chip index derive approximately 70% of their revenues overseas. Investors in these blue chips are expected to benefit from a dividend windfall as companies are able to increase pay-outs to shareholders. According to Capita, around two-fifths of the dividends paid by UK-listed companies are declared in dollars or euros, which will effectively boost dividends by £4.3 billion this year. This will more than offset some of the dividend cuts expected in some struggling sectors such as mining. This, combined with the prospect of further stimulus is why the leading UK index is up by around 6% since the referendum. Other companies have not been so fortunate: either they are overly-exposed to the domestic UK economy which is forecast by many to experience a recession and/or a significant portion of their input costs are denominated in another currency. UK housebuilders are an example of the former and airlines such as EasyJet an example of the latter. In terms of foreign investment, it is generally too early to forecast how leaving the EU might affect the attractiveness of the UK to foreign investors, however, we have seen a number of opportunistic bidders for UK companies of late as the falling pound makes their money go further. An example of this is the recent bid for ARM holdings by the Japanese firm Softbank in which the company admitted that the weakness of the pound had created an opportunity for them.
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5 © Capital International Group 2016
Country in Focus China
THURSDAY | 28 JULY 2016
With the headlines in the UK of Brexit, we have recently been through one of those phases where words simply drop from the headlines and China has been very quiet in recent months. However, that is not to say that things have been dramatically improving in the economy and we remain concerned longer term. As always timing is impossible to predict, but last summer’s equity market wobble was largely caused by Chinese GDP fears. In a recently published report, Moody’s estimate that the shadow banking system in China, accounts for a much larger part of banking activity than previously estimated. It could well be as high as a third of all assets and grew by over 10% in the first half of the current year. Overall, Chinese authorities official financing data has become a much less relevant way of tracking financial conditions and underlying economic activity. A glaring exclusion from the data is any loan made between government bodies, be that at a local or central level. Broad credit growth could therefore be running at close to a 20% annualised rate. It is worth remembering the sheer scale of the credit boom witnessed in China, with 43% of the growth in the GDP since 1996 accounted for by credit.
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Capital International
The Chinese banking sector has been financing growth through the interbank market but analysts have questioned the restructuring of some of the existing loan books. Over the past 18 months, the overnight interbank monthly lending volumes have grown by over 250%. Smaller institutions appear to be using ever more complex instruments to refinance and show on the balance sheet as ‘low risk’ investments. The China Banking Regulatory Commission has recognised this threat and recently issued guidance on such transfers and to increase the transparency of any non-performing loans they hold. There are also worrying parallels with the credit crisis emanating from the US in 2007 with the sub-prime mortgages. There was a mismatch between the length of the loans and the short term financing. Longer term lending in shadow banking in areas such as trust loans is typically 5-10 years, however they are financed usually from wealth management companies on a 3-12 month basis. At times of reduced liquidity, such as public holidays, there have been examples where banks are being forced to pay more than five times the normal rate, simply to secure the cash flow. Over the past six months the Chinese authorities have undertaken a significant stimulus on the economy, which has been channelled into the state owned enterprises. Recent economic data has shown that in June, profits from industry rose by over 5%, which is the fastest rate this year. The economic environment remains "complex and grim," a spokesman for the National Bureau of Statistics said at a briefing after the data release. Bright spots include a steady labour market, with the survey-based jobless rate for big cities stable at about 5.2%, and faster growth in the technology industry, he said, adding that easing factory-gate deflation has helped company profits.
Overall GDP growth in the second quarter was 6.7% but the key question is whether the authorities are able and willing to undertake further, aggressive stimulus. There is evidence that general government spending this year has been front end loaded and will slow as the year progresses. But the services sector appeared to have received little windfall from increased spending, continuing on a downward trajectory it began in Q4 2015 – albeit at a slower pace than in previous quarters: tertiary GDP notched a fall of 0.1 percentage points to 7.5% in Q2. Much of that fall derives from an unfavourable base of comparison. The second quarter of 2015 covers the upper reaches and peak of China’s stock rally, as well as a few weeks of tumultuous descent. That contributed heavily to revenues in financial services and delivered a huge boost to services sector growth. Interestingly the Yuan has been gradually depreciating in recent weeks, yet global markets have been sanguine. A Chinese currency devaluation has always been one of the big fears for global investors. Many economists within China have said the Yuan should be allowed to weaken further as the country’s economy slows, but the People’s Bank of China has to take care that such weakening is gradual enough it doesn’t speed capital outflows. Beijing’s exchange-rate manoeuvring has largely been driven by the Dollar. When it was weak, the PBOC mainly anchored the yuan to the Dollar and let it fall against the basket. Conversely, when the Dollar has advanced, it let the yuan weaken against it while keeping it largely stable against the basket. This year, the Dollar has weakened for longer than it has strengthened, resulting in a weaker yuan versus the basket than versus the Dollar. Another interesting current trend is that outward direct investment is now running at higher levels than inward foreign direct investment. This could add to the liquidity concerns that have been discussed regarding the banking system. We expect China to return to the headlines in the coming months and it might not make pretty reading.
Facts & Figures Capital ■■ Largest city
Beijing Shanghai
Official languages Chinese Recognised regional languages Mongolian, Tibetan, Uyghur, Zhuang, various others Ethnic groups
91.51% Han 1.30% Zhuang 0.86% Manchu 0.79% Uygur 0.79% Hui 50 other minorities
Demonym
Chinese
Government ■■ Party General Secretary & President ■■ Premier ■■ Congress Chairman ■■ Conference Chairman ■■ First-ranked Secretary of the Secretariat ■■ Secretary of Discipline Inspection Commission ■■ First Vice Premier
Unitary socialist one-party state Xi Jinping
Legislature Area Total Area Water (%) Population 2015 estimate 2013 census Density
Li Keqiang Zhang Dejiang Yu Zhengsheng Liu Yunshan Wang Qishan Zhang Gaoli National People's Congress 9,596,961 km2 (3rd/4th) 3,705,407 square miles 2.8% 1,376,049,000 (1st) 1,339,724,852 (1st) 145/km2 (83rd) 373 per square mile
GDP (PPP) Total Per capita
2016 estimate $20.853 trillion (1st) $15,095 (83rd)
GDP (Nominal) Total Per capita
2016 estimate $11.383 trillion (2nd) $8,239 (72nd)
Currency
Renminbi (Yuan; ¥) (CNY)
Time Zone
China Standard Time (UTC+8)
Drives on the
Right
Calling Code
+86
Internet TLD
.cn
7
Economy in Focus Ireland & Taxation FRIDAY | 30 SEPTEMBER 2016
The Irish economy is set to register significant growth in 2016 following exceptionally strong performances in 2015 and 2014. However, there is now a considerable contrast between the domestic and external components of growth. With the former, investment and particularly consumption are in the main fuelling present growth rates, while on the external trade side a certain softening of the growth performance is evident. It is now believed that GDP will increase by 4.3% in 2016 with growth moderating somewhat in 2017 at 3.8%. This weakening of the external trade performance is mainly due to two related considerations, the deterioration in global demand, which, in turn, is due to the continuing weakness of the Chinese economy and, secondly, Brexit-related issues. Concerns about the UK referendum had impacted, marginally, on the Irish economy in advance of the referendum. However since the UK’s decision to leave, high frequency data particularly for the domestic manufacturing sector suggests that the negative impact has persisted. The ultimate long term implications of Brexit will only be evident once the differing trade relationships between the UK, Europe and the rest of the world have been established. This is likely to take a number of years.
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The release of the recent National Accounts raises a number of important issues for analysts and policymakers alike. Difficulties with interpreting the National Accounts of a highly open, small economy have long been apparent, however these challenges have been exacerbated by recent developments. Very few people believe that economic activity in the Irish economy expanded by 26% in 2015 and while the Central Statistics Office is clearly bound by the accounting criteria mandated by Eurostat (i.e. the ESA2010 standard), it is imperative that a set of National Accounts be published which presents a credible narrative as to developments in the domestic economy. The figure is mostly explained by the open nature of Ireland’s economy and its attraction to U.S. companies seeking access to a 12.5% tax rate. The Irish economy grew by 26.3% in 2015, compared with the expected rate of 7.8%, after foreign companies that switched their base to Ireland were included in the value of its corporate sector, pushing up the value of the state’s balance sheet. The process of switching tax domicile after a merger or acquisition, known as an inversion, has increased in recent years, and Ireland has become a popular end destination in these corporate manoeuvres because of its low corporate tax regime. Several US companies, including pharmaceutical companies Allergan and Jazz Pharmaceuticals, security systems provider Tyco and medical technology specialist Medtronic have domiciled in Ireland by buying a smaller Irish-registered rival and inverting into an Irish corporate structure.
Corporations with assets overseas of €523 billion were headquartered in Ireland in 2014, up from €391 billion in 2013, according to the statistics office. A surge in aircraft imported into Ireland by leasing companies that send the jets out on loan to airlines was also among the main reasons for the economic growth. Lease operators based in Ireland account for about 20% of the global market, with sales of €7.8 billion. In a statement, Finance Minister Michael Noonan pointed out that growth numbers cut Ireland’s debt and deficit ratios. Trouble is, they carry downsides too. For one, tax inversions artificially inflate the size of Ireland’s economy. When the headquarters of a group of companies becomes resident in Ireland, all of its global profits may be counted as part of the nation’s gross national income, according to the ministry. Since 2008, that gauge has been boosted by about €7 billion thanks to corporate relocations, without accompanying substance or employment, the ministry has said. This in turn drives up the country’s contribution to the European Union budget, which is based on the size of the economy. Also, it leaves analysts and commentators at a loss to explain the state of the Irish economy. Some have looked at indicators like employment growth and tax revenue for a better gauge, and guessed Ireland’s underlying economic growth was about 5.5% last year. One area where the national accounting issues cause particular difficulties is in generating reliable metrics for evaluating the suitable fiscal and budgetary stance. In using alternative growth estimates, it is believed that the output gap has closed in the Irish economy. This is an important development on a number of fronts and confirms that the domestic economy has mostly recovered from the international financial crisis of 2007/2008. It also indicates that, subject to full indexation of taxation and social welfare bands, the 2017 budgetary policy should be neutral with fiscal policy neither explicitly stimulating nor contracting economic activity. The case for a neutral policy is compounded by the particularly strong increases in personal consumption in 2015. This, along with the continuing increases in retail sales observed in 2016, suggests that economic activity does not need to be further stimulated by reducing personal taxation levels. Additionally, recent research by ESRI researchers, illustrates the relatively stable nature of income tax vis-à-vis other taxation items as a source of Government revenues. It appears that it is important, from a fiscal stability perspective, that income tax remains a sizeable component of the overall taxation take of the State, and that any significant increases in Government expenditure at this point would increase the productive capacity of the economy.
Facts & Figures Capital and largest city
Dublin
Official languages National language
Irish - English Irish
Demonym
Irish
Government ■■ President ■■ Taoiseach ■■ Tánaiste
Unitary parliamentary republic Michael D. Higgins Enda Kenny Frances Fitzgerald
Legislature ■■ Upper house ■■ Lower house
Oireachtas Seanad Dáil
Area Total Area Water (%)
70,273 km2 (120th) 27,133 square miles 2.00
Population 2016 census
4,757,976 (120th)
Density
67.7/km2 (142nd) 175.4 per square mile
GDP (PPP) Total Per capita
2016 estimate $272.867 billion (56th) $58,373 (11th)
GDP (Nominal) Total Per capita
2016 estimate $254.596 billion (42nd) $54,464 (14th)
Currency
Euro (€) (EUR)
Time Zone
GMT/WET (UTC) IST/WEST (UTC+1)
■■ Summer (DST) Drives on the
Left
Calling Code
+353
Internet TLD
.ie
9 © Capital International Group 2016
Country in Focus Australia
WEDNESDAY | 31 AUGUST 2016
After over 20 years of continuous growth, low unemployment, low public debt, contained inflation and a stable and strong financial system, Australia began this year facing a range of growth constraints, primarily driven by a sharp drop in global prices of key export commodities. Demand for resources and energy from Asia, especially China, has stalled and significant drops in prices have impacted growth. Australia benefited from a dramatic surge in its terms of trade in recent years, although this trend has reversed due to falling global commodity prices. Australia is a significant exporter of natural resources, energy, and food. Australia's abundant and diverse natural resources attract high levels of foreign investment and include extensive reserves of coal, iron, copper, gold, natural gas, uranium, and renewable energy sources. A series of major investments, such as the $40 billion Gorgon Liquid Natural Gas project, will significantly expand the resources sector. Following growth of 2.5% in 2015, Australian GDP surged in Q1 2016 as the economy registered growth of 3.1% year on year. This is the fastest growth recorded in a quarter in over four years, driven principally by strong exports and household consumption (these two components of GDP have lately been the key growth drivers of the economy). However, business investment in engineering construction and new buildings fell sharply. An increased volume of iron and liquefied natural gas (LNG) exports supported growth, and helped offset the impact of lower commodity prices. A decade-long mining investment is now bearing fruit as exporters are able to continue production at low costs and maintain high profits despite falling prices. In addition, a steady depreciation of the Australian dollar has improved export competitiveness and boosted exports. Trade in services exports, which grew 15.8% year over year in Q1 2016, has benefitted from the falling value of the currency. Tourism, health care, and education were the key drivers of the improvement in the services sector balance. The appreciation of the Australian dollar since the beginning of this year may impact exports in the current quarter. However, the value of the currency is expected to reverse in the second half of the year. China’s economic slowdown and continued low commodity prices, together with the Federal Reserve’s decision to hike policy rates, will likely put downward pressure on the Australian Dollar.
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Strong employment numbers and rising house prices increased household wealth and facilitated higher household consumption expenditure and residential housing construction. Household consumption grew at a robust pace of 3.2% year over year, while dwelling investment grew 7.2% in Q1 2016.
Facts & Figures Capital ■■ Largest city
Canberra Sydney
On the other hand, private business investment continued to contract sharply in the March quarter. Growth in investment has been in the negative territory since Q1 2013 and shows no sign of recovery anytime soon. In fact, the contraction is turning bigger with every passing quarter. Investments in non-mining sectors have failed to compensate for the slack created by falling investments in the mining and energy extraction sector.
Official languages
None
National language
English
Demonym
Australian Aussie
Government
Inflation has eased lately since we last visited the economic outlook of Australia, reflecting the impact of low oil prices, appreciation of the Australian dollar leading to dampened import prices, and subdued domestic price pressures. The Reserve Bank of Australia (RBA) has also slashed its underlying inflation forecast to 1–2% in 2016 and 1.5–2.5% in 2017 during its release of the quarterly statement on monetary policy.
■■ Monarch ■■ Governor-General ■■ Prime Minister ■■ Chief Justice
Federal parliamentary constitutional monarchy Elizabeth II Sir Peter Cosgrove Malcolm Turnbull Robert French
Falling prices, weakening business investments, and an appreciating currency prompted the RBA to cut policy rates in May 2016. With inflation expected to remain low, further interest rate cuts are still on the cards this year. By bringing down the cash policy rate to an unprecedented low of 1.5%, the bank intends to boost the credit cycle and raise consumption demand. This may help the economy rebalance as it gradually transitions away from the investment to the production phase of the mining boom. But the economy faces some inherent challenges, and monetary policy interventions may not be sufficient to tackle those. Evidently, the economy is highly reliant on exports for growth rather than investments, which makes it susceptible to external shocks. Moreover, commodities are the biggest exported item, which makes exports vulnerable to international commodity prices. Lower commodity prices can potentially impact Australia’s GDP through a fall in the terms of trade, and can weaken export revenues, wage growth, and government revenues. At the same time, lacklustre business investment may hinder growth in the medium and long term. Historically, growth in GDP has improved employment as well as wages. However, in the past few quarters, robust economic growth has failed to generate strong income growth, as a result of which income earned by households has come under pressure. This does not bode well for future household consumption spending. Overall, the RBA expects GDP to grow 2.5–3.5% over the year to December 2016, and to increase to 3–4% over the year to June 2018, which is above the estimated potential growth of the Australian economy. However, if the economy does not transition away from export-led growth soon and if wages continue to remain stagnant, Australia may find it difficult to achieve these growth expectations.
Legislature ■■ Upper house ■■ Lower house Area Total Area Population 2016 estimate 2011 census Density
Parliament Senate House of Representatives 7,692,024 km2 (6th) 2,969,907 square miles 24,186,900 (51st) 21,507,717 2.8/km2 (236th) 7.3 per square mile
GDP (PPP) Total Per capita
2015 estimate $1.137 trillion (19th) $47,318 (17th)
GDP (Nominal) Total Per capita
2015 estimate $1.223 trillion (13th) $51,642 (9th)
Currency
Australian Dollar (AUD)
Time Zone
Various (UTC+8 to UTC+10.5) Various (UTC+8 to UTC+11.5)
■■ Summer (DST) Drives on the
Left
Calling Code
+61
Internet TLD
.au
11 © Capital International Group 2016
Economy in Focus
UK | Post-Referendum WEDNESDAY | 31 AUGUST 2016
At its latest monetary policy committee meeting, the Bank of England cut its headline interest rate to 0.25% from 0.5% - the lowest in its 322 year history. The move was widely expected, with the central bank guiding the markets to this conclusion in the aftermath of the EU referendum result. Other, less expected, measures included a stimulus package that will see the restarting of quantitative easing (QE) and cheap funding for private banks. The QE will be made up of £60 billion of government bond purchases and £10 billion of corporate bond purchases. The so-called Term Funding Scheme (to the tune of £100 billion) is designed to counteract banks’ reluctance to pass on the rate cut to customers (chiefly in the form of lower mortgage rates) given their declining profit margins.
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These actions coincided with a huge cut in its growth forecast for the UK economy in 2017: 0.8% from 2.3% and what amounted to a cumulative downgrade of 2.5% over the next 3 years. Despite the stimulus measures, the UK economy is expected to flirt with recession this year, with a further rate cut muted in the coming months to combat this, potentially taking the rate down to around 0.1%. Whilst the central bank felt the need to be proactive in restoring confidence, there was some scepticism surrounding the predicted effectiveness of the measures, with concerns abound that the central bank may be running out of ammunition. Recent comments from Mark Carney have alluded to this, warning that the bank, acting alone, would not be able to stabilise the economy.
There was a broad-based rally in the stock markets following the announcement, which has continued into August. UK-based multinationals have been boosted by the weakness of the pound, with the leading UK index up by around 8.5% from its level immediately prior to the referendum. With approximately 70% of earnings generated overseas, these companies receive a translation benefit when reporting in sterling as well as a boost to competitiveness from relatively cheaper exports. Domestically-focussed stocks have also picked up in the last few weeks as the domestic economy appears to be defying the negative predictions of stalling growth. Government bonds also rallied after the announcement of the £60 billion gilt purchase programme (according to Bloomberg, the UK has been the developed world’s best-performing sovereign bond market of 2016, with returns of over 13%). Recent data points to an economy that has largely shrugged off the worries surrounding the eventual exit from the EU in the short-term. Consumer spending in July was robust, with favourable weather and discounting leading to a like-for-like increase in sales of 1.1% from the same time last year. This contrasted with a 0.5% decline in June. Also, forecasted job losses have not materialised in the short-term as companies appear to be employing a waitand-see approach, with perhaps a reluctance to cut skilled workers before a clearer picture of the future business climate emerges. In fact, UK jobless claims actually declined in the month following the referendum, with the number of people unemployed at its lowest level since 2008. In addition, the number of employed people as a percentage of the total workforce has reached its highest level since comparable records began in 1971, at 74.5%. Foreign tourism is also showing signs of picking up, with the purchasing power of foreign tourists boosted by the weak pound. Not all the data is encouraging however. The housing market is looking vulnerable, with mortgage approvals dropping to a one-year low in June. Post-Brexit surveys of the construction, manufacturing and services sectors point to a contraction in GDP growth in the third quarter, with the uncertainty leading to potential cut backs in investment plans and hiring freezes. The coming months will provide a clearer picture of economic activity subsequent to the referendum. If the UK is to avoid a recession over the coming quarters, consumer spending will need to remain strong. Since this is the largest component of economic output, a drop would lead to slowing or perhaps negative GDP growth. It may also suggest that workers are increasingly concerned about job security and rising import prices amongst other things.
Facts & Figures Capital and largest city
London
Official languages and national language
English
Recognised regional languages
Scots Ulster Scots Welsh Cornish Scottish Gaelic Irish
Demonym
British Briton
Government
Unitary parliamentary constitutional monarchy Elizabeth II Theresa May
■■ Monarch ■■ Prime Minister Legislature ■■ Upper house ■■ Lower house Area Total Area Water (%) Population 2016 estimate 2011 census Density
Parliament House of Lords House of Commons 242,495 km2 (78th) 93,628 square miles 1.34% 65,110,000 (22nd) 63,181,775 (22nd) 255.6/km2 (51st) 661.9 per square mile
GDP (PPP) Total Per capita
2015 estimate $2.679 trillion (9th) $41,159 (25th)
GDP (Nominal) Total Per capita
2015 estimate $2.849 trillion (5th) $43,771 (13th)
Currency
Pound Sterling (GBP; £)
Time Zone
GMT (UTC) BST (UTC+1)
■■ Summer (DST) Drives on the
Left
Calling Code
+44
Internet TLD
.uk
13 © Capital International Group 2016
Fixed Income Report Third Quarter Review FRIDAY | 30 SEPTEMBER 2016
It has been yet another fascinating period for the global bond market as QE and an interest rate cut occurred in the UK. At the same time, bond investors were factoring in a US interest rate rise, as the labour market and the wider economy continued to improve. Volatility in the gilt market (based off 10-year gilt futures) has soared to close to the highest levels seen this century, on a par with the Eurozone debt crisis of 2011/12 and behind only the global financial crisis of 2008/09. In fact, investors have termed this situation the ‘new normal’, with slow growth, low yields and high volatility. The natural interest rate has been fundamentally reduced and in the US, the Federal Reserve may only have to tighten by 0.50% more to reach the target.
Given the challenges facing the UK, the OECD has recently suggested a more active use of fiscal policy. This would see a high level of public spending which would smooth any short term negative shortfalls. The Chancellor is likely to scrap the previous target of reaching a fiscal surplus by 2019/20 in the next Budget. Projects should focus on infrastructure areas such as rail and road and there could well be further initiatives on the housing market. Approximately £10 billion of projects would boost the overall GDP growth rate by 0.5%. The MPC are willing to maintain an accommodative stance despite some measures, such as an imminent 4% unemployment rate, indicating that tightening should occur. The tightening phase that the US Federal Reserve has now entered makes the appeal of US Treasuries more difficult. The ten year yield is now standing at 1.60%, having started the quarter at 1.47%. The upcoming Presidential election has also added to investor anxiety levels. Both candidates are also in favour of additional fiscal stimulus, with Trump’s proposals larger by a magnitude of 1% of GDP. However, economic growth for the rest of the decade looks steady at circa 2%, with no real issues for inflation either. The economic cycle is clearly in the very mature phase and certain indicators are flashing rising recessionary risk. This is likely to come from the corporate sector which is experiencing some retrenchment. The Bank of Japan has held off moving ever deeper into negative rate territory but has interestingly made a pledge to maintain the ten year yield at 0%. To do this, a more flexible approach to bond purchases will have to be made and the Bank will be conscious not to flatten the shape of the yield curve. Remember, they want banks to lend. This policy framework will indeed see a further easing in interest rates, probably in November from -0.1% to -0.3%. There has also been an adjustment in the inflation targeting, which is now aimed to be on average 2% over the course of the business cycle.
The ease in the UK’s monetary policy came in the wake of the Brexit vote and the UK bank rate of 0.25% could well be reduced further by the end of the year to only 0.05%. The Governor has already made it clear that he does not like negative interest rates. Quantitative Easing has also caused a significant flattening of the gilt curve relative to other markets. The ten year yield is currently standing at 0.70%, having started the quarter at 0.90%. The £10 billion corporate bond buying scheme has ultimately led to the highest issuance in the sector since August 2009. August saw a staggering £8.6 billion of investment grade issuance.
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Europe continues to be hampered by a poor structural backdrop, with significant slack in the labour market and poor longer term demographic factors. Germany for instance, pre 2008 averaged 1.8% per annum in productivity growth, this has now decelerated for the last five years and has actually fallen below zero. Despite the loose monetary policy and considerable ECB stimulus, there remains a lack of appetite for increased credit and so GDP growth will struggle. The consensus for 2017 is a slowdown to 1% growth. The ten year German bund yield remains at a negative -0.14%. The ECB is likely to extend the QE programme beyond March 2017 and may well take note of the afore-mentioned policy shift in Japan. The average yield on investment grade sterling corporate bonds is now at a record low at just over 2%. Prices in the UK have been boosted further by the Bank of England decision to launch a purchase programme. It remains unclear if this is an effective transmission mechanism to boost growth or simply stoking further an asset bubble. In the wider high yield market, there is also a substantial level of overvaluation with investors too relaxed on recessionary risks, notably in the US.
15 © Capital International Group 2016
Capital International Group Looking back | Moving forward
Capital International Group
CELEBRATING
YEARS IN BUSINESS
TUESDAY | 12 JULY 2016
August 2016 marked an important milestone for the Capital International Group as we look back on our extraordinary heritage of talent and achievements over the last twenty years.
In a previous article about the Group we started by saying, “In 1996, petrol only cost 52.9p a litre… …but more importantly, a corporate legacy was born. In this year, 20 years ago, in a small office in Castletown, a father, two sons and a small team opened the office doors to Capital International.” Although many that work for the Group today were not with the company then, a few still remember our humble beginnings at No.1, The Parade in Castletown. There was always the prospect of ‘from acorns grow mighty oaks’ and, with our vision of offering a fresh and innovative alternative, we set out with a steely determination to build a business that provided clients with a highly personalised service, whilst developing dynamic and flexible client solutions and a commitment to delivering on our core values of innovation, integrity and excellence. Over the last twenty years the financial services industry has changed immeasurably and throughout this time our business has evolved to meet the numerous challenges that this continuing process of change and development has created. We started out as a small traditional stockbroker and investment manager, servicing private clients and Island based businesses, and over the years Capital International has had to adapt, broaden its horizons and be prepared to constantly change in order to become the successful Group that we are today. Change is never easy and constant, rapid change to the external environment is often doubly difficult. This external turbulence is always challenging for business but it also creates opportunity. The resilience and determination of our managers and staff to overcome these challenges and adapt to the accelerating pace of the modern world has been a constant cornerstone that has allowed us to embrace the new opportunities that underpin the long-term growth and success of the Group.
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In an industry that is constantly changing, our success over the last 20 years is an accomplishment of which we can be justly proud. From that small acorn, first planted in Castletown back in 1996, we have become one of the Island’s foremost fully independent investment services groups, offering a wide range of investment products and services to a growing international client base. We have had to work hard to deserve our place within the Island’s financial services community and to be recognised for our achievements over the years, none of which would have been possible without the commitment and dedication of the remarkable people who work in the business. I feel privileged and honoured to lead and be part of such an amazing group of professional and dedicated individuals who make Capital International the progressive group of companies that it is today. We have never been shy of change, and much like a river winding its way to the sea, there are many twists and turns, often heading in different directions but ultimately always leading to the same goal. Looking forward will continue to evolve and develop our existing product suite and we will continue to encourage staff development and build upon our relationships with our business partners and external stakeholders across multiple jurisdictions. Š Capital International Group 2016
Anthony Long Chartered FCSI | Dip IoD
This year we celebrate our 20th anniversary with our services, staff and skills having grown significantly during this time. I can still remember the early days when we had less than ten staff. Today we employ over 75 professionals across two jurisdictions. Our culture has always and will continue to embrace three core values: innovation, integrity and excellence. These values not only describe our business conduct but also our personal behaviour, and underpins the way we create creation of value for our clients, employees and the wider Island community.
We recognise the importance of growing our international client base, focusing on the development of new business opportunities and the building of our professional intermediary relationship network. To support this, our strategic plans include further investment into the continued development of our web based platform solutions to financial intermediaries worldwide, and the delivery of a wider range of more clearly defined investment management solutions to the intermediary market in the Isle of Man.
Capital International Group Chairman
We encourage our staff to work across departments wherever possible, from customer services through investment management, to marketing and business development; from compliance and risk management, through to operations and IT. This approach gives everyone a firm grasp of how their individual roles impact the wider business and provides staff with a solid grounding of the wider aspects of the business that they may not be directly exposed to on a day-to-day basis.
CELEBRATING
YEARS IN BUSINESS
The recent appointment of our new Group Chief Executive, Greg Ellison, is also a major and significant development for us, further strengthening our management team and developing our internal capacity to fulfil our strategic objectives. It is clear to see that far from resting on our laurels, after 20 years we have plenty to keep us busy and so, it is with enormous pride that this year we celebrate 20 years of business on the Isle of Man and I would like to thank everyone who has been involved in helping the Capital International Group become the organisation it is today. I look towards the coming years with excitement and determination to continue delivering on the promises and values upon which the business was founded all those years ago. Anthony Long
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Capital International Group
10 out of 10 | Celebrating 10 years of excellence
Capital International Group
CELEBRATING
YEARS IN BUSINESS
MONDAY | 15 AUGUST 2016
Capital Treasury Services Limited, a leading provider of treasury services on the Isle of Man and part of the Capital International Group, is celebrating the Capital Liquidity Account being awarded the AAAf/S1+ rating by Standards & Poor’s for the tenth consecutive year across all three major currencies. When the Capital Liquidity Account was launched in 2007 the Bank of England base rate was up at 5.75% - the highest it had been since the turn of the millennium. Over the course of the following 18 months rates fell to 0.50% and is now at an unprecedented all-time low of 0.25%.
AAAf/S1+
Credit Quality & Volatility Rating Rated by Standard & Poor’s
Attitudes to cash have had to change, clients have realised that they can no longer chase yield whilst benefiting from liquidity and asset security. Today cash is no longer king, but it is not a dead asset class, far from it, as it still offers security and liquidity when professionally managed. Over the past decade amid some very challenging market conditions Capital Treasury Services has continued to excel and add real value to its clients and the Capital International Group. It is a dynamic, entrepreneurial and visionary part of the Group focused on treasury management, foreign exchange, cash management and payment solutions. The business provides an exciting and dynamic environment offering a professional, reliable and client driven service through the Group’s enduring values of innovation, integrity and excellence. This focus and drive has been rewarded year on year, and the Group is extremely proud to announce, for the tenth year running, that in August 2016 the three Capital Liquidity Managed Accounts (CLMA) have had their credit quality and volatility ratings affirmed by S&P Global Ratings.
CELEBRATING
YEARS OF EXCELLENCE
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in This is a fantastic achievement and we are extremely pleased that following their annual audit visit, the S&P Global Rating Service has once again assigned its AAAf1 credit quality rating and S1+2 volatility rating to the three underlying portfolios of the Capital Liquidity Account (CLA). ■■ Capital Liquidity Managed Account | GBP ■■ Capital Liquidity Managed Account | USD ■■ Capital Liquidity Managed Account | EUR “We are thrilled to celebrate ten years of continuous innovation, growth and success – the CLA has met every milestone it has set out to achieve while creating a new way to manage cash as an asset class,” said John Cookson, Managing Director of Capital Treasury Services.” “We are extremely proud of everyone involved in our continued success, in the affirmation and our business presence for the last 20 years. Long may it continue...” John added. “August is also our 20th anniversary as a financial services group here on the Isle of Man, and so we begin the month doubly pleased at our accomplishments over the years!” Greg Ellison, newly appointed Chief Executive for the Group went on to say that, “From experience I know it is an incredibly challenging process to be awarded the highest ratings with Standard & Poor’s, particularly with the economic challenges we have faced over the past decade.” “This rating is a valuable endorsement of the product and the skill with which the team manage our clients’ assets. The Group will continue to focus on providing clients with the level of dedication and professionalism that it has come to be recognised for.”
With low or zero returns on cash savings and investments the main concerns are asset security and reducing costs. As a consequence of continuous low base rates we have adapted and evolved, improving on the traditional methods of harbouring and moving cash, ensuring that assets are managed safely and efficiently with minimal client costs. Investment into technology has been a key focus for us, and as everything gets more sophisticated there is an increasing demand for a more joined up solution to simply holding cash or transacting payments. We have developed a multi-service, single-source platform offering efficient and dynamic cash management through the integration of our products and services. Our objective is to maximise returns whilst working within tight parameters to ensure asset integrity, and maintain liquidity, whilst making cash work more effectively. What we reflect in our approach to cash management is that asset protection is key. It is all about how cash is held, controlled and how its treated whilst being transferred across accounts.
Notes:
Standard & Poor’s Fund Ratings represent an opinion only, not a recommendation to buy or sell. The use of the graphical representation of the AAAf/S1+ rating on the underlying investment strategies for surplus cash within the Capital Account has been agreed by Standard & Poor’s. 1
The ‘AAAf’ rating assigned signifies the extremely strong protection the three underlying portfolios of assets provide against losses from credit defaults.
2
The ‘S1+’ volatility rating recognises that the three underlying portfolios of assets will demonstrate extremely low sensitivity to changing market conditions.
19 © Capital International Group 2016
Industry in Focus UK Oil Sector
WEDNESDAY | 07 SEPTEMBER 2016
The hangover of crude oil’s sharp falls in recent years has been evident in the historically low levels of new oil that is currently being discovered. In 2015 for instance, only 10% of the fifty year average amount annually found was discovered and this could well fall even lower in the current year. Indeed, the 2015 total oil discovered was the lowest figure since 1947 and reflected slashed exploration budgets. For the oil majors this presents a mixed picture, on the one hand the companies with a strong reserve profile should be in a good position. However, for longer term reserve replacement or for weaker portfolio companies it presents a major challenge. Oil has staged somewhat of a ‘dead cat bounce’ in 2016, confounding the pessimists who believed the price per barrel would drop to $20, it looks set to settle in the $45-50 range. Coincidentally this is very close to the perceived break-even of US shale production. Interestingly, despite the continued stimulus by Central Banks and poor GDP growth rates, crude oil demand remains robust. As recently as 2005, world crude consumption was just 84.7 million barrels a day. That’s since gone up to 95.1 million daily, a 12% increase in just 10 years. And that rise came during a decade when global GDP growth was rather sluggish. According to BP, fossil fuels remain the dominant source of energy powering the world economy, supplying 60% of the energy increase out to 2035. Within that, gas looks set to become the fastest growing fossil fuel, spurred on by ample supplies and supportive environmental policies. In contrast, the growth of global coal consumption is likely to slow sharply as the Chinese economy rebalances. Renewables are set to grow rapidly, as their costs continue to fall and the pledges made in Paris support their widespread adoption. Indeed recent Citigroup research suggests that crude oil will enjoy somewhat of an ‘Indian summer’ for the rest of the decade before the fundamental shift to renewables occurs. The issue for the market has been too much supply and recently US inventory numbers continued to surprise on the upside. To confirm this fact, the American Petroleum Institute reported that crude oil inventories grew by a surprising 4.464 million barrels last week. The market expectations for the API stats were for a 500,000 decrease in stockpiles according to a Reuters survey conducted before the release of the weekly missive. OPEC has to a large extent failed in stemming supplies and the quest for a production freeze seems destined to fail. For the UK oil majors such as BP and Shell, prices need to be above the $50 level to ensure that dividends and spending commitments are suitably covered by cash flows. BP has clearly faced a difficult period with the Deepwater Horizon settlements acting as a meaningful drag on financial resources.
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However despite this major distraction, the last decade of production history for the company actually reads very well. In the next five year period, the production decline rate is only forecast to be 3-5% per annum, over the last sixteen years this has averaged just over 5% for the company. With operations in over seventy countries and nearly 80,000 employees, management are focussing on the upstream operations to deliver shareholder value in the current pricing environment. For every $1 movement in the crude oil price this has a sensitivity of $300 million for the company which is quite extraordinary operational gearing. Shell are also honing strategy for the current situation and have dramatically reduced capital expenditure, which will be frozen until 2020. Asset sales are also planned and are expected to be $30 billion for 2016-18. The company have also earmarked up to 10% of Shell’s oil and gas production, including 5 to 10 country exits, for disposal. Management expect to make significant progress on the first $6-8 billion of this programme in 2016. At a recent Capital Markets Day the company increased the synergy benefits that will be able to be extracted from the recent takeover of BG Group. They are forecast to be $4 billion in 2017 alone. Upstream is also a focus for the company, they are developing competitive projects in Brazil and the Gulf of Mexico. Shell’s deep-water production could double, to some 900 thousand barrels of oil equivalent per day (kboed) in 2020, compared with 450kboed in 2015. Cash engines will focus on the oil sands, conventional oil and products. Organic free cash flow could reach $20-$25 billion and return on capital employed some 10% around the end of the decade, assuming $60 oil prices. This compares to 2013-15 averages of $12 billion and 8% with average $90 oil prices. The dedicated Exploration & Production sector has been facing a torrid situation and many will struggle to survive. Premier Oil is saddled with close to $3 billion of debt and has operations not only in the North Sea but in locations such as the Falklands, Pakistan and Vietnam. The recent Solan discovery in the North Sea shows that profits can still be made, with operating costs below $10 per barrel. The management team have had the hard decision to make to slash expenditure, which is clearly the lifeblood for such companies. The Falklands prospect for instance, will need £1.2 billion of expenditure before the first drop of oil is produced. Tullow Oil is a leading independent oil and gas exploration and production company. The focus is on finding and monetising oil in Africa and the Atlantic Margins. The current company portfolio of 119 licences spans 21 countries. The Group undertook a restructuring project in the last year that has resulted in improved organisational structure, efficient processes and reduced headcount of 37%, with an ongoing plan to deliver cash savings of around $500 million over a three year period. The company has $4.7 billion of debt with the shares having peaked at 1527p in March 2012 now trading at 230p. It is possible that the company may have to sell interests in both Kenya and Uganda to meet payments.
Royal Dutch Shell plc
BP plc Type
Public limited company
Traded as
LSE: BP
Industry
Oil and gas
Founded
1908 1935 1954 1998 2001
Anglo-Persian Oil Co. Anglo-Iranian Oil Co. British Petroleum BP Amoco plc BP plc
Type
Public limited company
Traded as
LSE: RDSA; LSE: RDSB
Industry
Oil and gas
Founded
February 1907; 109 years ago
Headquarters
The Hague, Netherlands (Headquarters) Shell Centre, United Kingdom (Registered office)
Area served
Worldwide
Key people ■■ Charles O. Holliday ■■ Ben van Beurden
Chairman CEO
Products
Petroleum, natural gas, and other petrochemicals
Headquarters
London, United Kingdom
Revenue
US$ 264.96 billion (2015)
Area served
Worldwide
Operating Income
US$ -3.261 billion (2015)
Key people ■■ Carl-Henric Svanberg ■■ Bob Dudley ■■ Brian Gilvary
Chairman CEO CFO
Profit
US$ 1.939 billion (2015)
Number of employees
94,000 (2015)
Subsidiaries
Shell Australia Shell South Africa Shell Canada Shell Chemicals Shell Gas & Power Shell Hong Kong Shell Nigeria Shell Oil Company Shell India
Website
www.shellcom
Products
Petroleum, natural gas, motor fuels, aviation fuels, petrochemicals
Revenue
US$ 225.98 billion (2015)
Operating Income
US$ -7.92 billion (2015)
Profit
US$ -6.4 billion (2015)
Number of employees
79,800 (31 December 2015)
Subsidiaries
Amoco
Website
www.bp.com
Tullow Oil plc Type
Public limited company
Traded as
LSE: TLW
Industry
Oil and gas exploration
Founded
1985 in Tullow, Ireland
Headquarters
London, United Kingdom
Key people ■■ Simon Thompson ■■ Aidan Heavey
Chairman CEO
Products
Oil and gas
Revenue
US$ 1,606.6 million (2015)
Operating Income
US$ -1,093.7) (2015)
Net Income
US$ -1,036.9 million (2015)
Website
www.tullowoil...com
21 © Capital International Group 2016
22 Page
The State of the World Post-Brexit
WEDNESDAY | 06 JULY 2016
2016 has been a tough year for bank stocks globally as they continue to deal with the fallout from legacy issues whilst facing a period of introspection regarding their future business models. A minority have fared well, trading well above pre-crisis levels (Wells Fargo for example); others are still trading well below this point (Standard Chartered amongst others). At face value, the sector appears to be relatively cheap on a valuation basis, however, is this enough to compensate for the inherent risks associated with it? Much rests on whether the assets on the balance sheet are valued correctly and their sensitivity to the prevailing economic conditions. On the former point, given that many banks are trading below book value, investors suspect not (a price-tobook-value below one indicates that the company is destroying shareholder wealth rather than creating it). Price-to-book value is a metric often used to compare banks since most financial assets are valued frequently (stale prices can render this measure inaccurate), however, there is still some discretion in how certain assets are valued. For example, some loan repayments may have a degree of uncertainty associated with them that banks may be reluctant to recognise on the balance sheet as any write-downs would lead to a reduction in the book value of equity (leading to a loss of shareholder wealth). Moreover, due to the economic sensitivity of bank assets (which comprise mostly of loans and credit to households and companies), a reduction in the value of these assets due to an economic downturn can have swift and significant repercussions for bank shares. An increased regulatory burden has also made life more difficult, with more stringent targets for equity capital ratios and frequent stress testing of bank balance sheets. There is no doubt that this harsher regulatory landscape will put a squeeze on profitability going forward, however, on the other hand, an adherence to these stricter rules may increase shareholder confidence that there are no further nasty surprises hidden in the reported figures. Generally speaking, the institutions that have performed the poorest in recent years have been those with significant investment banking operations. Given the volatile nature of these revenues, investors may be applying a discount due to this lack of visibility/consistency of earnings.
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Capital International
Impact of Negative Interest Rates
Until fairly recently, the concept of negative interest rate policy was something discussed only in academic circles; however, it is now an economic reality, with the central banks of the Eurozone, Japan, Switzerland, Sweden and Denmark having dropped their interest rates below zero over the last few years. In theory, negative rates should reduce borrowing costs for households and companies, thereby increasing loan demand. However, there are a number of factors as to why this mechanism is not functioning properly. Demand for loans is still relatively weak, household balance sheets are still being bolstered and business confidence remains fragile, with both groups continuing to horde cash. Individuals and businesses cannot be forced to borrow so banks are having to compete aggressively to obtain new lending business. This, combined with a reluctance to pass on negative rates to customers, tends to squeeze bank profits by reducing their net interest margins (the difference between the rates at which they borrow and offer loans). If profitability continues to fall then banks may actually scale back lending, contrary to the intended outcome of central bank policy. Moreover, if banks are effectively forced to charge depositors, cash may leave the system to reside ‘under the mattress’, depriving lenders of a crucial source of funding. For example, sales of safes in Japan have doubled from a year ago. Admittedly, this is more of an emotional response to negative interest rates than an economic one, however, it provides an insight into the fragile confidence of Japanese households and the potential failure of central bankers to communicate their intentions to the populous. On a larger scale, banks themselves are also indicating a willingness to defy their respective central banks by exploring options that would see portions of their excess deposits stored in vaults. Given that this would entail fairly high storage costs, it indicates the pressure that banks are under to find solutions to this issue. It also points to a natural resistance level to further rate cuts, whereby money leaves the system at an accelerating rate and monetary policy becomes increasingly ineffectual (the law of diminishing returns).
Regional Update United Kingdom
The immediate aftermath of the EU referendum result saw bank share prices tumble, with the sector falling on average by around 15-20%. According to Bloomberg, the trading days immediately following the referendum saw one of the sharpest negative shifts in analyst sentiment on record. Barclays, Royal Bank of Scotland and Lloyds Banking all had the ratings on their stock cut by at least six analysts. Each will face a multitude of issues and uncertainties in the coming months and years as potentially tortuous negotiations take place. Domestically-focussed banks such as Lloyds are exposed to the prospect of an ensuing recession in the UK, the risk of another push for a Scottish referendum and significant exposure to the domestic housing market which is showing signs of cooling. Others, such as Barclays, with large investment banking divisions, are faced with the loss of ‘passporting’, which allows them to operate across the EU without having to set up local subsidiaries. The more multinational banks such as HSBC look the most insulated at present, with their exposure to Asia now seen as a help rather than a hindrance (due to the non-Sterling revenue). Another potential headache for the UK government is that it could be lumbered with its remaining holdings in Royal Bank of Scotland and Lloyds for a lot longer than planned. Given that they are both now trading well below the government’s breakeven price, they will be reluctant to sell at a significant loss, putting additional strain on government resources.
Europe
Despite the rhetoric from European leaders, Brexit risks derailing the fragile recovery in Europe and, more seriously, putting the entire European project in jeopardy. Subsequently, reaction to the leave vote was extremely strong in European markets with some of the largest casualties being bank stocks. European banks were already going through a difficult and painful turnaround process without the additional uncertainty caused by Brexit – European banks need economic growth and confidence to improve and Brexit risks both of these. Italian banks have been especially hard hit given that they were already under significant pressure due to high levels of non-performing loans in the economy. The Italian government has already begun making contingency plans to support its banks with capital injections and/or loan guarantees, citing exceptional circumstances (which enables them to avoid EU rule breaches on state aid) Government bond yields in the so-called peripheral economies have been on the rise. Given that most Eurozone banks hold significant quantities of their government’s debt, there is a strong link between the health of the country and that of its banks, this is also an indication of heightened risk aversion. Moreover, further monetary easing is likely to hurt the banks who are already reluctant to pass on negative interest rates in full for fear of deposit flight.
23 © Capital International Group 2016
United States
Tellingly, US banks are more highly rated than their European counterparts, reflecting their greater success at tidying up their balance sheets, the relatively stronger state of the US economy (large banks tend to exhibit a fairly high correlation to GDP growth) and the closer proximity to a normalisation in interest rates (better margins).
That said, US bank stocks have still be weak this year due to moderation in the Federal Reserve’s tone on the future path of interest rates and worsening credit quality in some areas of the economy (shale gas companies for example). Given that stocks had rallied in anticipation of improving fundamentals, these developments were seen as a setback. Also, a dearth of mergers, acquisitions and initial public offerings have a depressed the revenues of the big investment banks such as Goldman Sachs. Other developments in the US include new accounting rules that come into force in 2020. Under these, US banks will be forced to recognise losses on loans starting from the point of origination (as previously mentioned, the current standards require write-downs only when losses become ‘probable’). This assessment of probable losses will be based on a combination of experience and forecasting. The rule change has run into opposition from banks who claim that it will deter lending and introduce further volatility in earnings. More recently, the Federal Reserve announced the results of its latest round of stress tests for 33 institutions. All passed barring the US subsidiaries of Santander and Deutsche Bank, which were quoted as having “broad and substantial weaknesses across their capital planning processes” (a sign that some of the European banks are still playing catch-up). The latest round of stress tests were an important milestone for banks seeking to distribute more capital to shareholders in the form of dividends and stock buy-backs and demonstrates that most institutions have significantly strengthened capital buffers and internal controls, given that the conditions of the tests were arguably more extreme than those faced during the financial crisis.
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Asia
Despite falling margins caused by a gradual slowdown, most banks in the region remain highly profitable. The region should also benefit from continued loose monetary policy in the US and the liquidity that this provides. There has been some cyclical deterioration in loan books, however, this remains fairly benign and central banks have the scope for a loosening of fiscal policy if necessary (they are slightly more constrained on the monetary policy front as easing could lead to unwanted currency depreciation). One country that is a cause for concern is China, given that a significant slowdown would be a drag on the whole of Asia, however, if the constraints of volatile capital flows and tighter liquidity constraints ease, then there will be further scope for further interest rate cuts.
Summary
Despite all the negativity surrounding the sector, there are a number of potential bright spots, especially for the better capitalised banks operating in the right areas. Sentiment is seemingly about as bad as it can get. Banks will be a beneficiary of (eventual) interest rate rises, margins have stopped falling, de-leveraging has taken place, litigation risks have subsided, capital buffers have been built up and companies are increasingly in a position to return capital to shareholders in the form of buy-backs and dividends. And breathe... Overall, risks still dominate the investment decision, however, we see opportunity in broad exposure to funds and/or investment trusts investing in 'financials' and well as some of the leading individual names.
25 © Capital International Group 2016
News in Focus
South Africa Update MONDAY | 26 SEPTEMBER 2016
South African Municipal Elections Undoubtedly the major event in third quarter was the Municipal elections held on 3 August. The political climate over the past few years has changed quite radically with the African National Congress (ANC) losing support against a background of non-delivery of services, corruption and scandals like the President’s home, Nkandla.
The table below sets out the results of the past four Municipal elections. Only the percentage votes obtained by the largest four parties are tabled as no other party obtained more than 1% of the votes.
South Africa GDP Growth Rate 6% 4.1% 2.2% 1.6%
3.3% 2.0%
0.8%
0.3%
4% 2%
0.4%
0% -1.6% Jul 2013
Jan 2014
Jul 2014
Jan 2015
Jul 2015
-2%
-1.2%
-2.0%
Jan 2016
-4% Jul 2016
Industry Growth Rates Q2 figures as reported 09 September 2016 Finance
2.9%
Trade
1.4%
Government
1.2%
Manufacturing 0.8% 0.1%
Construction
2.9%
Transport -1.8% -0.8% Mining -20%
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-10%
Agriculture
0%
11.8% 10%
EFF
4.25
8.19
2011
61.95
23.94
3.57
-
2006
64.82
16.24
7.53
-
2000
59.39
22.12
9.14
-
The ANC has remained firmly in control of 8 of the 9 provinces in SA, with the exception of the Western Cape that remains a DA stronghold with a 63.33% vote. However, Gauteng, which is the wealthiest and second most populated province, has become hotly contested. The ANC only obtained 45.86% of the votes in Gauteng, compared with 37.21 to the DA and 11.36 to the EFF. The big shock for the ANC was the decision by the EFF to vote with the DA in both Johannesburg and Pretoria where the ANC has now lost control. To add insult to injury Nelson Mandela Bay (Port Elizabeth) went to the DA with 46.71% of the votes against the ANC that obtained 40.92%. Cape Town remains DA with 66.61% of the votes. Also the ANC failed to take control of President Zuma’s hometown of Nkandla, where the government spent over R250 million on upgrades and security. Nkandla remains in control of the IFP which increased it shares of the votes to 54% compared with 46% in 2011. Just prior to the election President Zuma spoke at a rally on 29th July. He stated that “The ANC has a task to rebuild and reconstruct the country to create a society as envisaged in the freedom charter. We need to be voted into power to move the country forward. Your vote is important to take this journey forward. You must vote in big numbers”
Looking forward it is not certain whether the ANC will now speed up economic reform to win back voters, or will dig their heels in and become introspective. There have been numerous calls for Zuma to step down and with the next General Elections set for 2019, we wonder if the ANC will “recall” Zuma.
Electricity
Mining
IFP
26.90
The reality during the elections was that in many areas voters did stay away in protest and the ANC suffered as a result. Disillusioned ANC voters are also asking what real changes have taken place in the 22 years that the ANC has been in government. With their backs against the wall their desperation was evident in Zuma’s further statements that “the ancestors are turning their backs against you if you leave the ANC and you will have bad luck”
8.1%
Personal Srvs
DA
53.91
The swing away from the ANC over the past 10 years has been significant as the ANC has fallen from almost a two-third majority to just above a simple majority. One could argue that virtually the total number of votes lost by the ANC has been gained by the DA. However the EFF received over 8% of the votes that were partially from the ANC Youth League who remained loyal to Julius Malema and from minor parties who supported the new party.
The votes have moved across to the Democratic Alliance (DA) that now has a black leader and is offering a viable alternative to the ANC and also to the very outspoken Economic Freedom Fighters (EFF) which is headed up by the former ANC Youth League leader. Even the Inkatha Freedom Party (IFP) managed to recoup some votes lost in previous elections.
4.9%
ANC 2016
20%
Zuma vs the Treasury Since the debacle in December 2015 when the then Finance Minister Nene was replaced by the little known David van Rooyen on the 9th December 2015 and Gordhan was reappointed on the 13th December, there has been an ongoing spat between Zuma and the Treasury. In public Zuma and Gordhan appear to be on good terms, but behind the scene Zuma apparently putting pressure on Gordhan to keep him from interfering in State Owned Enterprises (SOE’s). Recently the Hawks (special investigation arm of the police) requested Gordhan to report for questioning. He refused to report. Zuma has confirmed the reappointment of Dudu Myeni as the chairperson of South African Airways (SAA) – the state owned, loss-making airline. Treasury officials had opposed her re-appointment. SAA has been surviving on state -guaranteed loans and has failed to submit financial statements for the past two years. Treasury has refused to grant it an additional loan of R5billion. Myeni’s reappointment comes two days after asset manager Futuregrowth said it had halted any further lending to SOE’s over concerns of their governance. In December 2015 Zuma denied rumours that he had had an affair with Myeni or that their ties had led to the firing of Finance Minister Nene, who had rebuked Myeni for mismanaging a R1 billion leasing deal with Airbus. Critics say that government plans to form a new committee, supervised by Zuma, which would oversee SOE’s thus limiting Treasury’s control over these firms. The Treasury is also reported to have clashed with Eskom over its efforts to renew a coal-supply contract linked to the Gupta family, who are friends with Zuma and in business with his son. This ongoing mismanagement of SOE’s, nepotism and the inability, or lack of will, to root out corruption is likely to have very adverse consequences, including a downgrade of SA’s sovereign debt rating.
Impact on the Rand & bond rates
Politics has had a major impact on the value of the rand and bond rates since December 2015. The firing of the Finance Minister on 9th December 2015 is plainly evident in the spike in the rand and bond rates in the attached chart. Also the move on Pravin Gordhan and announcement by Futuregrowth in August shows up on the chart. The Brexit effect is also prominent in late June. In spite of all the negative politics it is encouraging to see the improvement in the rand in recent months and the normalization of bond rates since December 2015. The SARB has kept interest rates unchanged in its September meeting and the Governor has indicated that rates might be close to their peak in this interest rate cycle.
South African GDP up in Second Quarter
On a brighter note GDP for Q2 increased by 3.3%. This positive quarter was mainly due to a turnaround in mining and a big improvement in manufacturing and agriculture. This better quarter was in spite of many commentators expecting SA to enter a technical recession. On a year-on-year basis the economy grew by 0.8% in Q2 compared with a contraction of 0.1% in Q1. If commodity prices remain on the increase and the drought is broken in coming months, then SA could avoid a rating downgrade. However, against the background of poor state management of SOE’s outlined above, the rating review at year-end will be a close call.
27 © Capital International Group 2016
Market in Focus Global IPOs
WEDNESDAY | 14 SEPTEMBER 2016
Global IPO proceeds thus far in 2016 are running at just below $50 billion, this is way below the average experienced in the last decade. There are clearly some important months to follow before the calendar year closes. But there will need to be an acceleration in issues if we are to surpass the previous low year, which was 2008 when $85.2 billion was raised in new issues. To put this into context, the peak year was 2007, when $266.6 billion was raised, closely followed by both 2010 and 2014, when on average $240 billion was raised. Why is this year so poor? Liquidity levels amongst investors are high, equity markets such as the US are near all-time highs and global economic growth is steadily growing. To some extent, the very fact that liquidity is plentiful means that companies can gain finance from private means, rather than having to raise equity on the markets. At the same time, regulatory changes have simultaneously made it easier to stay private and harder to be public. There are also signs that investors have become highly sensitive to valuation levels, which for certain sectors (notably technology) have simply been too high. The performance of those companies that have listed in the current year is also an important factor, with around 25% of these issues currently trading below their issue price. The Brexit vote in the UK created a short to medium term paralysis and this has been combined with US Presidential elections later in the year. Biotechnology companies accounted for a major boost to IPO’s in 2015, however with more scrutiny on pricing in the sector and profit taking, the sector has been a poor performer in 2016. In Asia, we could well see the largest IPO of the year take place as the Postal Savings Bank of China has launched the biggest initial public offering since the record float of Alibaba two years ago, in a deal that could raise up to $8.1bn in Hong Kong. The bank has a staggering 505 million retail customers and is the fifth largest Chinese lender by assets. The IPO is being supported by other state influenced companies, these ‘cornerstone’ investors are CSIC Investment One and Shanghai International Port Group, who have agreed to invest $2.2 billion and $2.1 billion respectively. Victory Global Group, a unit of aviation conglomerate HNA Group, will buy $1 billion of shares, while other cornerstone investors will buy smaller stakes. Interestingly, it has only been the Chinese state influenced companies that have really raised any funds this year.
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Initial Public Offering
Initial public offering (IPO) or stock market launch is a type of public offering in which shares of a company usually are sold to institutional investors that in turn, sell to the general public, on a securities exchange, for the first time. Through this process, a privately held company transforms into a public company. Initial public offerings are mostly used by companies to raise the expansion of capital, possibly to monetise the investments of early private investors, and to become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Although IPO offers many advantages, there are also significant disadvantages, chief among these are the costs associated with the process and the requirement to disclose certain information that could prove helpful to competitors. The IPO process is colloquially known as going public. Details of the proposed offering are disclosed to potential purchasers in the form of a lengthy prospectus document. Most companies undertake an IPO with the assistance of an investment banking firm acting in the capacity of an underwriter. Underwriters provide several services, including help with correctly assessing the value of shares (share price) and establishing a public market for shares (initial sale). Alternative methods such as the dutch auction have also been explored. In terms of size and public participation, the most notable example of this method is the Google IPO. China has recently emerged as a major IPO market, with several of the largest IPOs taking place in that country.
Advantages
When a company lists its securities on a public exchange, the money paid by investors for the newly issued shares goes directly to the company (primary offering) as well as to any early private investors who opt to sell all or a portion of their holdings (secondary offering) as part of the larger IPO. An IPO, therefore, allows a company to tap into a wide pool of potential investors to provide itself with capital for future growth, repayment of debt, or working capital. A company selling common shares is never required to repay the capital to its public investors. Those investors must endure the unpredictable nature of the open market to price and trade their shares. For early private investors who choose to sell shares as part of the process, the IPO represents an opportunity to monetise their investment. After, once shares trade in the open market, investors holding large blocks of shares can either sell those shares piecemeal in the open market, or sell a large block of shares directly to the public, at a fixed price, through a secondary market offering. This type of offering is not dilutive, since no new shares are being created. Once a company is listed, it is able to issue additional common shares in a number of different ways, one of which is the follow-on offering. This method provides capital for various corporate purposes through the issuance of equity (see stock dilution) without incurring any debt. This ability to quickly raise potentially large amounts of capital from the marketplace is a key reason many companies seek to go public. An IPO accords several benefits to the private company: ■■ Enlarging and diversifying equity base ■■ Enabling cheaper access to capital ■■ Increasing exposure, prestige, and public image ■■ Attracting and retaining better management and employees through liquid equity participation ■■ Facilitating acquisitions (potentially in return for stock)
Largest IPOs
■■ Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
Company
Year
Amount
The Alibaba Group
2014
$25.0 billion
Agricultural Bank of China
2010
$22.1 billion
There are several disadvantages to completing an IPO:-
Industrial and Commercial Bank of China
2006
$21.9 billion
American International Assurance
2010
$20.5 billion
■■ Significant legal, accounting and marketing costs, many of which are ongoing
Visa Inc.
2008
$19.7 billion
General Motors
2010
$18.2 billion
NTT DoCoMo
1998
$18.1 billion
Enel
1999
$16.6 billion
2012
$16.0 billion
Prior to 2009, the US was the leading issuer of IPOs in terms of total value. Since that time, however, China has been the leading issuer, raising $73 billion (almost double the amount of money raised on the New York Stock Exchange and NASDAQ combined) up to the end of November 2011. The Hong Kong Stock Exchange raised $30.9 billion in 2011 as the top course for the third year in a row, while New York raised $30.7 billion. © Capital International Group 2016
Disadvantages
■■ Requirement to disclose financial and business information ■■ Meaningful time, effort and attention required of management ■■ Risk that required funding will not be raised ■■ Public dissemination of information which may be useful to competitors, suppliers and customers. ■■ Loss of control and stronger agency problems due to new shareholders ■■ Increased risk of litigation, including private securities class actions and shareholder derivative actions
29
Country in Focus South Africa
MONDAY | 19 SEPTEMBER 2016
Facts & Figures Capital ■■ Largest city
Pretoria (executive) Bloemfontein (judicial) Cape Town (legislative) Johannesburg
Official languages 11 languages
Afrikaans, Northern Sotho, English, Southern Ndebele, Southern Sotho, Swazi, Tsonga, Tswana, Venda, Xhosa, Zulu
Ethnic groups (2014)
80.2% Black 8.8% Coloured 8.4% White 2.5% Asian
Demonym
South African
Government
Unitary constitutional parliamentary republic Jacob Zuma Cyril Ramaphosa
■■ President ■■ Deputy President Legislature ■■ Upper house ■■ Lower house Area Total Area Water (%) Population 2015 estimate 2011 census Density
National People's Congress National Council National Assembly 1,221,037 km2 (25th) 471,443 square miles Negligible 54,956,900 (25th) 51,770,560 42.4/km2 (169th) 109.8 per square mile
GDP (PPP) Total Per capita
2015 estimate $725.004 billion (30th) $13,215 (90th)
GDP (Nominal) Total Per capita
2015 estimate $323.809 billion (35th) $13,215 (88th)
Currency
South African Rand (ZAR)
Time Zone
South African Standard Time (UTC+2)
Drives on the
Left
Calling Code
+27
Internet TLD
.za
30
Factors affecting South Africa like the recent Political infighting, paralysis and dragging feet with the urgent and much needed transformation of SA parastatals, can possibly cost the country dearly in December. Moody’s Investor Service, one of the three biggest credit ratings agencies in the world, warns in its quarterly overview that South Africa’s continued guarantees to loss-making parastatals, for example the South African Airways, indicate the avoidance of difficult and contentious structural reforms. This comes shortly after the Treasury (led by finance minister Pravin Gordhan) gave guarantees worth R5 billion to the SAA to keep it afloat. Nonetheless Moody’s state that it thinks political infighting remains the biggest risk to South Africa’s credit rating, even though it is moderate but persistently on the increase. External to South Africa’s politically motivated risk factors but inherently linked to the perception of risk is the fund flows from foreign investors who are hunting for yield, which they still find in the ZAR. This is however heavily influenced by the outlook for anticipated US rate rises, as no-one wants to be caught holding a devaluating ZAR currency of US rates are set to rise. But the US rate rise in itself has been the subject of speculation, even among Fed officials themselves it seem. SA’s rate of inflation is still much higher than that of most developed nations and can rise further given exchange rate shocks that can happen from time to time initiated by capital flight from SA for example of the US were to suddenly raise their interest rates on the back of a Trump election victory. SA has a well-developed financial sector and technologically advanced stock exchange which enable foreign investment into the country at the push of a button. Problem is this enables the outward flight of capital just as easily, for instance if Janet Yellen announces a bigger than expected interest rate increase and the market is caught by surprise. This week all eyes will be focused on the American Federal Reserve (the Federal Open Market Committee (FOMC) and its 12 members, seven from the Board of Governors and five of the Federal Reserve Bank presidents). In addition to the FOMC, which is widely expected to keep rates on hold, the Bank of Japan (BOJ) is seen as easing their policy slightly, but we will only know when both the FOMC and BOJ concludes their respective meetings on Wednesday. More importantly than what they do is what is said following the meetings and their expectations. Markets can show signs of volatility in lieu of the fact that post meeting comments are being made this week. The ZAR/USD closed this Friday (16/9) at R14.18 to the dollar versus the previous Friday’s R14.41 to the dollar. All eyes will be on FOMC commentary whether a December rate hike in implied or suggested as the markets are pricing in a 12-15% chance of a Fed rate hike following the conclusion of this meeting. Hawkish sentiment pertaining to a possible December rate hike however can steer market volatility into overdrive.
parastatal /ˌparəˈsteɪt(ə)l/
adjective 1. (of an organisation or industry, especially in some African countries) having some political authority and serving the state indirectly. noun 1. a parastatal organisation.
This will not support ZAR and it can weaken on the back of dollar strength, however it can also be supported by BOJ if they lower their interest rates. This will take ZAR to stronger levels. America and Japan’s rate decisions will be announced on Wednesday. The South African Reserve bank (SARB) will make its interest rate decision known on Thursday, which is widely expected to remain unchanged. Also this weeks in the interest rate decision space is other African countries by name of Ghana, Kenia and Nigeria, all announcing their interest rate decisions this week. The SARB has increased its repo rate by 125 basis points (1.25%) since July 2015. Growth remains weak but inflation improved (6% year-on-year in July ’16 following a 6.3% rise in the previous period), so all 15 economists which took part in a Bloomberg survey expects the rate to remain unchanged on Thursday. Moody’s is currently in South Africa for its annual conference and it is expected that deputy president Cyril Ramaphosa together with Pravin Gordhan be meeting with the credit ratings agency. Early next month a South African delegation headed by Gordhan and Lesetja Kganyago, president of the Reserve Bank, will head to the USA to ease any concerns investors from the USA might have and to market SA a good country for them to invest in. Growth has picked up in SA since the last ratings were carried out and there is even a trade surplus on the current account of R12.5 billion, from a deficit of R22 billion in the first six months of this year.
The big challenge will be the SA parastatals, with their financial stability at stake, dependent on repeated bailouts by the SA government fiscus. To name a few parastatals under the spotlight of Moody’s review: Escom (Electricity Supply Company), Sanral (South African National Roads Agency), DBSA Development Bank of South Africa and two other state owned entities as well. Their individual ratings have already been put under close watch for a possible future downgrade. Any further attacks on our finance minister, Pravin Gordhan, will push the country over the “cliff edge”. If there are any meddling in the finance minister’s attempts to restructure or to limit his power in the process of restructuring the troubled parastatals this will be a sign to the credit ratings agencies to assume a negative stance on South Africa’s credit rating. Brazil is chilling reminder of how the recent impeachment of former president Rousseff lead to a popular uprising against her and her government. Unrelated to this Moody’s kept the credit rating of two of SA’s gold producers, AngloGold Ashanti (Baa3) and Gold Fields (Baa1), unchanged and changed the outlook form stable to positive. This shows that they have faith in these producers and that it is not yet too late for the government to at least try and tackle the problems of the numerous parastatals under their control.
31
Industry in Focus
Global Agriculture & Agribusiness FRIDAY | 23 SEPTEMBER 2016
According to the UN’s Food and Agriculture price index, general food prices rose to their highest level in 15 months in August, recording a jump of around 7% in the August to August period. Commodity Soybeans
220
200
180
Return Comments 14%
Despite record production, prices continue to rise, with demand being driven by changing dietary habits in China and other developing countries (increasing pork consumption requires animal feed imports).
Corn
-10%
Production outlook higher than initial estimates on better crop yield. Has fared better than wheat due to steady growth in corn ethanol use.
Wheat
-20%
Generally record crop yields globally. Price at a decade low (below the cost of production in some cases).
Cotton
9%
Tighter stocks globally, however, price rises have been kept in check by inventory drawdown (especially in China). India will be a significant importer this year due to pest and drought issues.
Coffee
21%
Long drought in Brazil has affected supplies (large harvests in other countries partially offset this). Coffee production seen as very susceptible to climate change. Global consumption continues to grow.
Sugar
27%
Price at a 4-year high. Expected global supply shortage in 2016/2017 has reduced existing inventories. Currency effects have also contributed to higher prices (Brazilian Real vs. US Dollar especially).
After a long period of falling food prices on the back of favourable weather conditions and subsequently large inventories, food prices appear to have bottomed out, with dairy, vegetable oils and sugar leading prices upwards.
32
Food Prices Monthly FAO food price index
160
140 Jan 2013
Jan 2014
Jan 2015
Jan 2016
Aug 2016 Source: FT.com
So far, 2016 has seen some very disparate returns in the soft commodity space. After enjoying strong rises throughout April and May, grain prices fell sharply in June as markets reacted to a slew of fresh data. Whilst soybeans managed to retain some of their gains, primarily on the back of robust Chinese demand, corn and wheat prices were driven down to multi-year lows after reports of good weather and record harvests began to materialise, especially in the US and Eastern Europe. The over-supply in these particular markets is expected to last into 2017 and is forecast to put significant pressure on farmers, especially with prices falling below the cost of production in some regions/countries. The resilience of the corn price relative to wheat has been largely due to continued growth of corn ethanol usage. Whilst this ignites the ‘food vs. fuel’ debate in periods of rising corn prices, it has added a stable source of demand, helping to dampen some of the volatility associated with this particular commodity. Despite this, corn and wheat prices do tend to be fairly correlated as they share a number of interchangeable uses: feed stock for cattle for example, whereby the cheapest option will be used. Other soft commodities have seen strong gains this year as production fails to keep pace with demand. As well as unanticipated weather-related supply disruption, some soft commodities are benefitting from changing dietary habits and consumer tastes in the emerging markets (China’s growing taste for pork is creating robust demand for soybeans for pig feed for one). Also, global demand for coffee is expected to hit a record this year as people all over the world consume more of the beverage, leading to higher prices for coffee beans.
Agribusiness ‘mega-mergers’
Years of falling crop prices, reduced investment in seeds and crop protection by farmers and cheap access to finance have combined to create an environment in which companies seek industry consolidation in order to create cost synergies and to cover gaps in their product range, as the industry moves towards a holistic approach, offering everything from diseaseresistant seeds to advanced pesticides. The most recent round of mega-mergers in the seeds and crop protection sector was kick-started by a ‘merger-of-equals’ between Dow Chemical and DuPont. The combined company DowDupont is planning to split into three independent, publicly traded companies, one of which will be a pure-play agriculture company. Providing the deal goes ahead without antitrust issues and subsequent forced divestitures, the new company would generate annual revenues of around $18 billion and become a very big player in the industry. Subsequent to this deal, the next target was Syngenta, attracting an opportunistic bid from Monsanto in a deal that looked to transform the industry. After a number of sweetened offers failed to weaken Syngenta’s resistance, a friendly counter-offer was put forward by ChemChina in a deal that would rank as the largest ever foreign acquisition for a Chinese company. This deal is not without its hurdles, since part of the funding is being put forward by Chinese state-owned entities, triggering possible investigations by governments on national security grounds. This turn of events resulted in Monsanto looking vulnerable to a takeover itself, which duly came from Bayer. The combined company would be the largest agribusiness firm in the world with approximately a quarter of global seed and pesticide sales. Consequently, what was once the ‘big six’ industry players will become a ‘big four’ if all the deals go through largely unimpeded. Elsewhere, two of the largest fertiliser companies, Agrium and Potash Corp, have announced their intentions to merge. The deal would join the world’s largest potash producer with the world’s largest agricultural retailer. This potential shrinking of competitors is causing concern for industry stakeholders, especially farmers, who fear a reduction in choice in what is an already concentrated market, dominated by a few large companies, and could ultimately drive up food prices for consumers. For example, Monsanto, Syngenta, Bayer, DuPont, Dow Chemical and BASF, between them, control around two thirds of the global seed market.
Global Seed Market Market share, 2013 (%) Other 29% Bayer 3% Dow Chemical 4%
KWS 4% Limagrain 5% Syngenta 8% Dupont 21%
Monsanto 26% Source: FT.com
US Pesticides Market Revenue share, 2013 (%) Other 25% Dupont 6% Monsanto 8% Dow Chemical 10% BASF 13% Bayer 18% Syngenta 20% Source: FT.com
Outlook
Despite the bifurcated nature of the soft commodity market so far this year, a diversified exposure to this asset class has produced an attractive return. Looking forward, if one were to expect a rising interest rate environment in the not-too-distant future, then agricultural commodities may well continue to be an attractive asset class, given that historical returns in periods of rising interest rates have tended to be strongly positive.
33
Capital International Group News Ten years with the Group
Everyone within the Group would like to congratulate Chris on this milestone and look forward to the next 10 years!
ASIP
Chris joined us after originally working in London as a fund manager and a further 5 years here on the Isle of Man. With a great knowledge-base and experience he has been instrumental in building our investment management business over the last decade and is a well-known figure in the local investment community.
Chris Bell BCom
Chris Bell, our senior investment manager celebrated his 10 year anniversary with the Capital International Group with a toast from the Group Chairman, Anthony Long.
Senior Investment Manager Capital International Limited
MONDAY | 26 SEPTEMBER 2016
Manx 100 Race SUNDAY | 31 JULY 2016
On Sunday 31st August, John Venables took part in the Manx 100 which is a 100 mile off road mountain bike race with 16,000 feet of total ascent. The course is designed to test rider’s fitness, mental strength and endurance and has been ranked at number 1 by Red Bull as the toughest mountain bike race in the UK. All at the Capital International Group would like to say a huge congratulations to John for completing this race. One crash and one puncture later, John finished in 16th out of 59 with an incredible time of 12 hours 17 minutes. Congratulations to John and to everyone else who took part!
Tough Mann Challenge SATURDAY | 06 AUGUST 2016
A massive congratulations to the tough Capital International Group men and women for completing the annual Tough Mann Adventure Challenge on 06 August. After a lot of mud, sweat and tears they all managed to finish the 10 kilometre course which included 25 obstacles and a 1,000 ft. ascent and are even looking forward to participating again next year!
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New Chief Executive joins the Group TUESDAY | 12 AUGUST 2016
Greg Ellison MBA
Chief Executive Officer Capital International Group
BSc (Hons) C.Dir
The Capital International Group is delighted to announce the appointment of Greg Ellison to the Board of Capital International Group Limited and subject to regulatory approval, he will be appointed Group Chief Executive Officer. Greg is without question one of the Island’s most experienced and highly regarded senior executives. His appointment comes at an exciting time in the development of the Group, which continues to grow at an impressive rate, with much of this growth now coming from international markets. The next five years are likely to see the Group expanding further into new markets, with the Isle of Man remaining as the Group’s headquarters’ and operational centre of excellence. Staff numbers are now approaching 80 and are expected to continue to increase both in the Isle of Man and overseas.
New appointments MONDAY | 22 AUGUST 2016
We at the Capital International Group are pleased to announce that, in August 2016, Olivia Ramsay and Tamsin Webb have both received promotions, and become our two newest managers. Over the years they have worked extremely hard and these two promotions recognise the fact that both Olivia and Tamsin have taken on the extra responsibilities expected of them as managers.
Our two newest managers Capital International Limited
Olivia Ramsay & Tamsin Webb
We hope you will join us in congratulating Olivia and Tamsin on their well-deserved promotions.
Greg moved to the Isle of Man in 2006 as Head of Banking for Barclays Wealth before being appointed as Managing Director in 2008 with responsibility for over 1,000 Barclays’ offshore employees covering operations, retail, corporate and HNW business across the Isle of Man, Jersey and Guernsey. In 2011 Greg was appointed Chief Executive Officer of Boston Group Ltd, the Isle of Man based family office and fiduciary business. Over the last 5 years he has successfully led the development of Boston from a small Corporate Services Provider and family office into a leading multi-office fiduciary and corporate finance business with offices in London, Malta, Dubai and the Isle of Man. He attained his MBA from Henley Management College and is an IoD Chartered Director. He is also Non Exec Chairman of the board of Junior Achievement on the Isle of Man. Commenting on the appointment Group Chairman, Anthony Long, says ‘Greg’s appointment is a significant and exciting development for the Group, further strengthening our management team. Greg’s experience will be invaluable in helping us to maximise opportunities and to drive forward our international footprint and business development with greater confidence, purpose, in-house experience and expertise. I have worked closely with Greg at Junior Achievement and as a client over many years, I know that he will add tremendous value to the Group in the years ahead.’ Commenting on his appointment, Mr Ellison says ‘I am very excited to be joining the Capital International Group. The business has done tremendously well since setting up on the Isle of Man over 20 years ago and it is a privilege to be given this opportunity. I feel great optimism about the future for the Group and look forward to working with all the teams at Capital International to continue to deliver strong growth in an increasingly international business.’
35
Capital International Group Celebrating 20 years
CELEBRATING
YEARS IN BUSINESS
36
This document has been prepared for information purposes only and does not constitute an offer or an invitation, by or on behalf of any company within the Capital International Group of companies or any associated company, to buy or sell any security. Nor does it form a constituent part of any contract that may be entered into between us. Opinions constitute our judgement as of this date and are subject to change. The information contained herein is believed to be correct, but its accuracy cannot be guaranteed. Any reference to past performance is not necessarily a guide to the future. The price of a security may go down as well as up and its value may be adversely affected by currency fluctuations. The company, its clients and officers may have a position in, or engage in transactions in any of the securities mentioned.
Isle of Man | Head Office Capital International Group Capital House Circular Road Douglas Isle of Man IM1 1AG www.capital-iom.com T: +44 (0) 1624 654200 F: +44 (0) 1624 654201 E: info@capital-iom.com
Capital International SA Office NG101A Great Westerford 240 Main Road Rondebosch 7700 South Africa www.capital-sa.com T: +27 (0) 21 201 1070 E: info@capital-sa.com
The regulated activities are carried out on behalf of the Capital International Group by its licensed member companies Capital International Limited, Capital Treasury Services Limited, Capital Fund Services Limited Capital Financial Markets Limited and Capital International Fund Managers Limited are all licensed by the Isle of Man Financial Services Authority CILSA Investments (PTY) Ltd, trading as Capital International SA, is licenced by the Financial Services Board in South Africa as a Financial Services Provider (FSP No 44894) Capital International Limited is a member of the London Stock Exchange Registered Address: Capital International Group, Capital House, Circular Road, Douglas, Isle of Man, IM1 1AG Registered Address: CILSA Investments (Pty) Ltd, Office NG101A, Great Westerford, 240 Main Road, Rondebosch 7700, South Africa
CIG - Investment Review Q3 - 2016 - V1.01-10.16
South Africa Office
Capital International
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