2020 has been characterized by a low-hanging cloud of uncertainty as we have witnessed local and global economies reel under the unexpected, immediate crises bought about by the COVID-19 pandemic. Efforts to reopen global economies are cautiously underway and it appears that the most severe scenarios concerning global health and the resultant economic outcomes have been largely averted.
More than ever, the Shariah investment space is vindicated by the teachings that guide daily life and economic investments — rooted in the sacred law. Shariah compliant funds may not invest in highly leveraged companies, eliminating options within the traditional finance sector. Companies selected for investment need to have closely managed debt and cash balance levels to avoid the payment, or receipt, of excessive interest — and in the current climate — less-geared companies have tended to outperform highly indebted ones.
We believe that environmental, social and governance (ESG) considerations are an imperative part of the overall investment process, with quantitative analysis of material ESG factors and the inclusion of this in the valuation process. This is a dynamic process requiring a unique approach for each company.
Review of 2020
For the nine-month period to the 30th September 2020, the FTSE/JSE SWIX All Share Index lost 6.6% and the average general equity fund was down 6.9%. Local Shariah equity funds were down 3.9% on average over the same period.
Although recovering sharply from the second quarter economic activity trough, the South African economy is showing signs of permanent damage following years of mismanagement and the extended, highly restrictive lockdown — particularly regarding a significantly depressed labor market and chronically low business confidence. GDP growth for 2020 is set to go backwards in real terms and the fiscal position remains uninspiring.
Well-articulated economic revival plans rely too heavily on policy implementation from weakened state institutions that do not draw sufficiently from private sector cooperation. Prospects have deteriorated significantly due to weak pre-COVID-19 states, and South Africa’s post-COVID-19 recovery will take longer than the rest of the world due to inherent structural economic weaknesses. This is fueled by the increased risk caused by unsustainably high sovereign debt, chronic unemployment and poor human capital development. However, there is evidence of anti-corruption actions from strengthened local state bodies, which is aiding growing confidence.
The medium-term outlook for emerging economies is mixed with differing exposures to low energy prices, the decimated tourism industry and various pandemic-related impacts. Governments in developed countries have responded to the healthcare crisis and the resultant pausing of large parts of their economies with aggressive fiscal stimulus packages. Together with a dramatic easing of the monetary policy, this has tempered the economic damage from the crisis, providing a powerful buffer to financial markets up to this point. We expect increased volatility when fiscal stimulus inevitably wanes, and inflation and interest rates rise from the current low levels.
Globally, the immense increase in government debt balances owing to aggressive fiscal stimuli will hamper future, long-term growth and uncertainty remains high. Positively though, the global economy entered the crisis in a buoyant position, with healthy consumer dynamics in most developed markets and a moderating but strongly growing Chinese economy that has resumed activities quickly. Developed market consumer health appears to have been largely preserved through extensive fiscal and monetary support, and increased savings rates. Early consumer indications have fared better than presumed and in many regions, housing activity is now at healthy levels. Consumer expenditure sustainability is, however, being put to the test as fiscal support tapers off and permanent job losses begin to bite.
Preview of 2021
We believe that there will be casualties among local companies with weaker balance sheets and whose management teams do not adapt to the new environment. We continue to hold material positions in unpopular areas of the South African equity market where we find idiosyncratic investment cases offering improving prospects that are not wholly dependent on local economic performance.
We maintain a position well below maximum permitted limits in offshore markets, mainly due to the exciting expected returns we see in our South African holdings. Our global stock picks are widely diversified across (mostly) developed markets and have somewhat of a quality cyclical orientation. These stand to benefit from a less negative economic environment than is reflected in their very low share prices.
Could the key to weathering the storm lie in the adoption of a wholly ethical investment practice to reinforce better business models and stronger management teams? Quality managers thrive in the transparent application of Shariah investment principles, which should not constrain returns over the long term.
Although the principles are based on Islamic teachings, the underlying ethical framework is ideal for socially-conscious investors seeking robust returns.