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PORTFOLIO COMMENTARY

Global equity markets endured an incredibly challenging second quarter of 2022 that included the US Federal Reserve (Fed) opting to accelerate the pace at which they hike interest rates, owing to historic levels of inflation which are proving to be less transitory than initially anticipated. In addition to this, the possibility of a recession in the near future, which only increases as the Fed raises interest rates, has compounded the downward pressure encountered this quarter on global equity markets. In light of these circumstances, we’ve seen equity markets continue to retreat sharply following a disappointing first quarter.

While the longer-term performance of the Sasfin Innovation Portfolio remains strong at 19% per annum in USD terms, the portfolio experienced a decline of 19.7% over the second quarter of 2022, compared to a 24.2% decline in its benchmark, the Russell Small Cap Complete Growth Index.

This decline was fairly broad-based as there were not many stocks that escaped the selling pressure, though some fared better than others. The stocks and ETFs that constitute the Sasfin Innovation Portfolio are companies that are more closely associated with economic growth that tend to fare poorly in recessionary periods and were consequently harder hit. Historically speaking, these were companies whose valuations benefitted from the low interest rate environment because future cash flows were discounted at low interest rates. It computes then that in an environment where interest rates are rising substantially, these future cash flows are now discounted at much higher interest rates, negatively affecting companies’ valuations and leading to relatively greater falls in their stock prices.

Within the context of the Sasfin Innovation Portfolio, the holdings that held up best in the quarter were wireless and video communication technology firm, InterDigital, the iShares Global Clean Energy ETF, and satellite communication group, Iridium Communications. Conversely, the holdings that came under the most pressure were The Trade Desk, a digital advertising platform offering a marketplace that allows customers to purchase various types of advertisements, the ARK Genomic Revolution ETF, and the networking hardware firm, Arista Networks.

Given the change in the macroeconomic environment, from a low-interest, high-growth economy to a high-interest, low-growth economy, we’ve had to be a lot more selective in our decision-making process to reflect the changes in circumstances. To this extent, we’re employing a bigger focus toward high quality companies that are trading at attractive valuations and have consistent and sustainable reinvestment rates back into the company. In this climate, we believe that holding high conviction, best-in-class companies where growth justifies current valuation is not only the best insulation we can have against macroeconomic turbulence within the context of the tech- heavy constituents of this portfolio, but also provides us with a more robust long-term outlook.

As such, after a significant decline over the past 12 months amid an increased competitive environment, we decided to sell our direct holding in device streaming manufacturer, Roku. In addition to the concerns regarding the mounting competition, the company is also facing massive supply chain constraints and has been negatively affected by the global push toward a return-to-work policy. While other concerns may be transitory, we expect the threat of competitors to remain an issue for the foreseeable future. Despite Roku being among the early innovators in the streaming space, a company’s competitive advantage in terms of how robust the demand for their product is can only be seen upon the entrance of new competitors. In this regard, Roku fared poorly and subsequently we could not continue to justify holding a company that can no longer be considered best in class.

The proceeds of this sale were used to bolster our direct exposure to the semiconductor space through the addition KLA Corp., a leader in the process control and yield management systems universally required in the semiconductor industry. In addition to this, we remain constructive on the digital entertainment and e-commerce theme and after selling Roku we identified a more focused, niche exposure to the sector in the form of online casino provider, Evolution AB, a Swedish company engaged in the development, production, marketing, and licensing of business- to- business casino solutions to gaming operators.

Looking forward, the investment team is actively exploring adding new direct holdings in the clean energy space to complement our existing ETF holding. Our primary objective remains ensuring that we achieve long- term capital appreciation without taking on excessive risk for our clients.

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About the Author

Muhammed Wagley
Portfolio Manager, Sasfin Wealth