It’s now time to invest in an alternative reality
LAST year was not a good one for equity investors. The FTSE/JSE all share index returned just 2.6 percent, including dividends. In rand terms, offshore returns were even poorer. The MSCI World Index was down 4.6 percent.
There is little to indicate that these trends are likely to reverse over the next 12 months. High levels of market uncertainty are making it very difficult to know where to look for returns.
“Coming into 2017, things have been significantly more uncertain than they have been over the past five or six years,” says Brian McMillan, the head of retail sales at Investec Structured Products. “Political and economic tension has been heightened following the Brexit vote and the election of Donald Trump, and that makes it very difficult for investors.”
Even if markets do turn positive this year, the expectation is that equity returns will be below the long-term average.
“We’ve had a long bull run, and now equities, both locally and internationally, are looking pretty expensive,” McMillan says. “If you look for value, there is not a lot out there.”
Exposures One of the interesting things to come out of last year was the performance of equity products offering alternative exposures. Certain local smart-beta index-trackers excelled. For example, the CoreShares DivTrax, which tracks the S&P South Africa Dividend Aristocrats Index, gained 17.13 percent over the year, while the Satrix Rafi 40, which tracks the FTSE/JSE Rafi 40 Index, also performed strongly, finishing the year 18.97 percent higher.
This shows that there are opportunities for investors to find performance in products that do not align closely to the broad market index.
However, Zack Bezuidenhout, the head of South Africa and sub-Saharan Africa at S&P Dow Jones Indices, says although smart-beta products offer alternative sources of return, investors need to consider their options carefully.
“What we noticed last year is that the top performers from 2015 were the worst performers of 2016, such as momentum strategies,” Bezuidenhout says. “While value strategies, which have performed poorly for a couple of years, did well.”
He, therefore, suggests that investors consider multi-factor strategies that have diversified sources of risk and return.
“Blending these factors provides better protection,” Bezuidenhout says. “For example, a combination of momentum and value works better than just using one of the two.”
He also recommends considering strategies that cap their exposure to any one stock, particularly in South Africa. “Capping certain stocks at 10 percent means that you are not overexposed to a single company, like Naspers, which in the normal market-cap index is currently sitting at around 20 percent,” Bezuidenhout says. “That makes investors very vulnerable.”
Another appealing option for investors is to use structured products that offer a guaranteed pay-off profile. These products usually multiply any market gains up to a certain point, while also offering protection against losses.
“I think this year a lot of people will be looking at protecting their capital, and that’s one of the main reasons to invest in structured products,” McMillan says. “Downside risk is high at the moment, and that means it’s vital to have a level of capital protection.”
The chance to see increased returns is also appealing, given how muted expectations are.
“Getting very high real returns for marginal increases in the market is attractive right now,” McMillan says. “A geared upside is great when you are not expecting a very high nominal return.”
For example, the Investec USD S&P500 Digital Plus product, which is due to mature in April, has gained 73.76 percent since inception. Investors, therefore, not only have the certainty of knowing that their capital is protected, they can also see greater upside if markets are positive.
‘I think this year a lot of people will be looking at protecting their capital, and that’s one of the main reasons to invest in structured products.’
Long term Investors need to be aware that when using structured products they will be giving up some liquidity, because they generally need to be held over three to five years for the full benefit to be realised. In the current environment, however, this may be less of a concern than the benefits derived from being invested in a product with a predefined return.
“Structured products are not trading instruments,” McMillan says. “They are long-term investments that provide investors with defined levels of capital protection and upside to suit their risk-and-return appetite. And in a year that is already seeing most analysts scratching their heads, investors would be wise to allocate some assets that provide a level (of) certainty.”