Quarter 1

2017

ONTRACK INSIGHT

The first quarter of 2017 started with so much promise for South Africa and its beleaguered economy. Commodity

prices were recovering; the rand was strengthening; inflation was dipping; and the country received much-needed

rainfall.

However, much of these positive developments came undone during the last two weeks of the quarter when

President Zuma decided to axe highly-regarded finance minister Pravin Gordhan. This was followed by downgrades

of SA’s government debt rating ─ a development that may yet have far-reaching consequences for SA’s political-

economic landscape.

Given this turbulent backdrop, it is no surprise that local investors are again witnessing elevated volatility in financial

markets. With this in mind, Investment Analyst Nerina de Clercq introduces local volatility indexes in the SAVI

Investor, while Portfolio Manager Wim Prinsloo simplifies SA’s downgrade to junk status. In the last section, we

explain True North’s portfolio positioning in light of these events.

THE SAVI INVESTOR by Nerina de Clercq, Investment Analyst

Investors are frequently plagued by their emotions, causing them to behave irrationally when making investment

decisions. These irrational emotions are reflected by the volatility of the market ─ defined as the rate at which the

price of a security changes for a given set of expected returns. High volatility suggests that the market is fearful and

uncertain, whilst low volatility on the other hand suggest more certainty of the future.

Volatility indices

The first volatility index that was developed is known as the VIX and it measures the volatility of the S&P500 Index

(the go-to index for the American stock market). Subsequently, the JSE developed the SA Volatility Index in order to

measure the level of uncertainty in the SA equity market. This was the first volatility index for an emerging market.

Figure 1 on the next page clearly shows that, during the 2008 recession, the SAVI (orange line) reached a level above

50, indicating extreme levels of uncertainty. This was expected as market downturns cause investors to panic and

react more irrationally than they would otherwise.

Figure 1: The SA Volatility Index (SAVI) from 2007 to 2017

Source: Thomson Reuters Eikon

In 2009, the JSE launched the SAVI Dollar Volatility Index (Purple Line in Figure 1) ─ a forecast of the 90-day implied

volatility of the rand against the dollar which enable investors to estimate the risk and sentiment towards the local

currency market. As the performance of the rand provides us with an indication of sentiment for political and

country risk, the SAVI Dollar Volatility Index is useful in providing an indication of general investor confidence in SA.

As seen from Figure 1, the picture has changed quite significantly in the aftermath of President Zuma’s cabinet

reshuffle, with the rand plummeting by almost 11% between 24 March to 4 April. The SAVI Dollar Index changed

from 14.13 to 17.98, reflecting significant uncertainty and deteriorating confidence with regards to the SA political-

economic landscape.

Rand-hedges protect local investors in times of uncertainty

Generally, one would expect the two lines to move together but due to the large amount of rand-hedge stocks in

the index (roughly 65%), the lines have started to diverge as the weaker currency leads to stronger rand-hedge

performance and thus a stronger SA Equity market. In light of this we currently find ourselves in a relatively low

index volatility environment but a highly volatile currency market.

Conclusion

Political risk will continue to hover around SA’s markets as the battle for power in the ANC intensifies towards the

end of the year. In this rapidly changing investment environment diversification is key and volatility will present the

“SAVI” investor with an opportunity to buy a great share at a discount when others are fearful and acting irrationally.

56 41.5

2007 2009 2011 2013 2015 2017

SAVI Dollar Volatility Index reflecting

heightened uncertainty after Zuma’s

reshuffle

SOUTH AFRICA GETS JUNKED by Wim Prinsloo, Portfolio Manager

The fallout from the political upheaval within South Africa had further repercussions after two major credit rating

agencies (S&P; Fitch) labelled South Africa’s government bonds as “junk”.

What does this mean?

In a manner that is similar to a person’s own credit rating, companies and countries have their ability to pay debt

rated by international credit rating agencies (like S&P or Fitch).

In the wake of president Zuma firing SA’s well-respected finance minister, Pravin Gordhan, two of the world’s

biggest rating agencies downgraded their assessment of South Africa’s bonds to junk (from investment grade). The

thinking is that without the involvement of the former finance minister, South Africa’s government is more likely to

spend too much money and mismanage the finances of state-owned companies (of which there are many).

The Bigger Picture: Offshore diversification is essential for South African investors

South Africa, like many emerging markets, typically have less stable governments and less established economic

systems. This makes it more susceptible to political developments that threaten investors’ interests. South Africa’s

current malaise is reminiscent of both Turkey and Brazil’s struggles in recent years, when both countries were

downgraded to junk status amid internal political problems and government overspending.

Local investors should not be naïve about the country in which they invest as South Africa carries greater risk than

developed markets like the US, Germany and Australia. Offshore diversification is therefore essential.

ECONOMIC DATA

CPI: February ( ’17 ) 6.30% PPI: February (’17 ) 5.60%

Unemployment (Q4 ’16) 26.50% Repo Rate 7.00%

Prime rate 10.50% GDP (Q4 16) 0.30% q/q

SOURCE: STATS SA, SARB

STOCK OF THE MONTH

32 Napier Street, Tower Property Fund

Overview

Tower Property Fund (Tower) is a Real Estate Investment Trust that owns a diversified portfolio of 50 properties to

the value of R5bn. Tower’s properties are located in South Africa (72%) and Croatia (28%), with Gauteng and the

Western Cape its predominant local locations. The Fund aims to add value through active property management

and has taken a leading role in “greening”1 its portfolio.

Investment case

Tower is in the process of developing 77 high-end residential apartments in its crown-jewel asset – the Cape Quarter

precinct in Cape Town.

Cape Quarter is a landmark development in Cape Town’s CBD and is evolving into what will be one of the most

iconic and desirable mixed-use centres in this world-renowned city. Tower’s developments are geared to meet the

demand from the public who increasingly wish to take up residence in the inner city of Cape Town and have access

to the amenities at the Cape Quarter.

1 ‘Greening’ refers to improving a property’s efficiency in the use of energy

Development costs for these units are R31 000/m2 and they are expected to sell for a whopping R61 000/m2,

ultimately generating a net profit R150 million for Tower (and its shareholders).

Impression of Tower Property Fund’s residential development at Cape Quarter in Cape Town

Source: Tower Property Fund

Apart from the abovementioned developments, Tower expects to generate a further R100 million in profits from

the sale of some of its none-core South African properties. The R250 million proceeds that Tower expects to

generate from the developments and asset sales will be reinvested back into the business to boost its growth.

What returns are we expecting?

Tower currently trades at a 9% dividend yield and we estimate that its Net Asset Value will reach R11.36 per share

by the end of 2019. Given a current share price of only R8.60, we estimate 20%+ total returns p.a. from this

undiscovered small-cap in the SA Listed Property market.

FUND COMMENTARY FOR Q1 OF 2017

TRUE NORTH IP FLEXIBLE EQUITY FUND

As a result of its large percentage of rand hedge and offshore holdings, the True North IP Flexible Equity Fund (TNFE)

was effectively competing against the strengthening rand during the past few months and returned only +0.98% in

1Q17. In comparison, the JSE All Share Indexed returned +3.78% and the MSCI World Index returned +4.45% in the

quarter.

Nevertheless, the political turmoil that erupted with the firing of Pravin Gordhan has vindicated our strategy to hold

high offshore exposure through rand-hedges (Naspers, Steinhoff, Reinet etc.) and best-in-class offshore-listed

stocks (Apple, Alphabet etc.).

A deepening political crisis in the months ahead will see offshore-focused companies back in favour – a situation that

TNFE is well positioned for given that:

• TNFE has 5 offshore holdings and 8 locally listed rand-hedges (out of a total of 24 holdings)

• 60% of TNFE’s revenues are derived in offshore markets.

• Only 27% are derived from SA, with 13% in cash/Nedgroup Flexible Income.

• TNFE has very little exposure to SA financials (only Capitec and Santam), the sector that should come under the

most pressure in coming months.

TRUE NORTH IP ENHANCED PROPERTY FUND

True North IP Enhanced Property (TNEP) was basically flat (+0.25%) in 1Q17, in contrast to the SA Listed Property

Index’s +3.78% return. The year started well for local property stocks, but this very much ended on the last day of

the quarter when Gordhan-gate exploded.

Approximately 28% of TNEP is invested in local property assets and this proportion of the fund could well come

under pressure in the months ahead, if one considers that a company like Growthpoint sold-off by 20% when

Nhlanhla Nene was unexpectedly removed as finance minister.

On a positive note, 60% of the fund is invested in offshore property markets and these assets should counteract

losses from local properties. A further 12% is held in cash and the Nedgroup Flexible Income Fund, and could be

deployed into the market if attractive entry-prices are provided by this crisis. All-in-all, TNEP should hold its ground

and is well positioned relative to local-only property mandates.

For more details on holdings and performances, please view the fact sheets which can be downloaded from our website:

www.tncm.co.za.

5 Disclaimer:

This document is for information purposes only and is not intended for the solicitation of new business. True North Capital

Management shall not accept any liability or responsibility of whatsoever nature and however arising in respect of any claim,

damage, loss or expense relating to or arising out of or in connection with the reliance by anyone on the contents of this

document.