When the bulls stop run­ning

Di­ver­si­fied as­set al­lo­ca­tion funds the flavour of the month

Finweek English Edition - - Focus on creation and preservation of wealth -

SOUTH AFRICAN IN­VESTORS have got used to run­ning with the bulls, with the lo­cal eq­uity mar­ket reg­is­ter­ing dou­ble-digit growth for the last 15 quar­ters in suc­ces­sion – beaten in nom­i­nal terms only by the bull mar­ket of the late Sev­en­ties.

Lo­cal in­vestors have rarely had it so good. So good, in fact, that many are ques­tion­ing the sus­tain­abil­ity of the cur­rent trend and are turn­ing their thoughts to strate­gies that are more aligned with wealth preser­va­tion.

No sur­prise then that more di­ver­si­fied as­set al­lo­ca­tion funds have be­come the flavour of the month. Th­ese funds, which rep­re­sent a fairly so­phis­ti­cated prod­uct line-up, aim to ap­por­tion funds across a wide range of dif­fer­ent as­sets in or­der to lower the risk of be­ing ex­posed to only a sin­gle as­set class, while aiming to achieve the best pos­si­ble re­turns for a given level of risk.

And be­cause they in­vest in most types of as­sets, in­clud­ing eq­uity, cash, bonds, prop­erty, in­ter­na­tional as­sets and al­ter­na­tive in­vest­ments, as­set man­agers are able to con­struct what they be­lieve is the op­ti­mal so­lu­tion for in­vestors in terms of their de­sired risk and re­turn ob­jec­tives.

Ac­cord­ing to Al­wyn van der Merwe, se­nior port­fo­lio man­ager at Old Mu­tual In­vest­ment Group’s Macro Strat­egy In­vest­ments bou­tique, the fo­cus of the as­set man­ager should be to not only max­imise in­vest­ment re­turns over the longer term, but also to ac­tively make the cor­rect tac­ti­cal ad­just­ments to as­set al­lo­ca­tion dur­ing pe­ri­ods of short-term mar­ket volatil­ity when as­set per­for­mance can vary con­sid­er­ably. “As­set al­lo­ca­tion unit trusts of­fer the in­di­vid­ual in­vestor ac­cess to a fund man­ager’s skill and ex­per­tise to take ad­van­tage of such mar­ket op­por­tu­ni­ties on their be­half.”

Old Mu­tual In­vest­ment Group strate­gist Peter Brooke says while the value of SA eq­ui­ties had been di­min­ished in the wake of the bull run, di­ver­si­fied as­set al­lo­ca­tion ve­hi­cles were still likely to pro­vide su­pe­rior re­turns in 2007 and be­yond, rel­a­tive to other as­set classes.

“Fol­low­ing the vig­or­ous growth of 2006, the mar­ket has re-rated sub­stan­tially ver­sus its off­shore coun­ter­parts. It fin­ished the year at a price-earn­ings ra­tio (p:e) of 17,3 times ver­sus 15,8 times at the end of 2005. On both a his­toric and for­ward ba­sis, our mar­ket p:e is high and it could go even higher – ev­ery­thing de­pends on global mar­ket sen­ti­ment.”

Hen­drik Pfaff, CEO of San­lam In­vest­ment Man­agers (SIM) Re­tail says the re-rat­ing meant that SA in­vestors should be tak­ing a se­ri­ous look at di­ver­si­fi­ca­tion. “We have moved into a com­fort zone as far as trend­ing mar­kets, which move in a one-way di­rec­tion, with small cap up, and off­shore down. But life starts to­mor­row as far as in­vest­ment de­ci­sions go, and ev­ery­thing doesn’t look like mov­ing in one-di­men­sional di­rec­tion in the com­ing pe­riod.”

Brooke agrees that the cur­rent state of the mar­ket points to lower re­turns ahead. “Based on our own re­search and anal­y­sis and prospects of a slow­down in cor­po­rate earn­ings growth, go­ing for­ward we ex­pect eq­ui­ties to record a re­turn of around 12% on a sus­tained, longert­erm ba­sis.”

This may be a tri­fle dis­ap­point­ing com­pared to the re­turns de­liv­ered over the past four years, yet it’s still at­trac­tive rel­a­tive to the longer-term re­turns likely to be gen­er­ated by the bond and money mar­kets. “Over the longer-term we ex­pect cash to yield 6% to 7%, while bonds should yield about 8%, as in­fla­tion con­tin­ues its struc­tural de­cline. Eq­ui­ties will cer­tainly out­per­form th­ese num­bers,” says Brooke.

He says that while eq­ui­ties look ex­pen­sive rel­a­tive to cash, with 12-month cash yields cur­rently of­fer­ing a 9,5% risk-less re­turn com­pared to an ex­pected medium-term re­turn for eq­ui­ties, the key risk for the in­vestor is rein­vest­ment risk. “The main rea­son cash is cur­rently at­trac­tive is that it is of­fer­ing a rel­a­tively high real re­turn of about 5%. But we ex­pect in­fla­tion to peak soon, with in­ter­est rates also likely to come off in the medium term and this will di­min­ish the re­turns of­fered by cash.”

Brooke says that the out­look for listed prop­erty also re­mains sound as good sec­tor fun­da­men­tals re­main in place, with an ex­pec­ta­tion of sus­tain­able growth in dis­tri­bu­tions over the next sev­eral years.

Pfaff says the SA eq­uity mar­ket is at par­ity with the S&P in­dex on a rel­a­tive ba­sis, rep­re­sent­ing a strong re-rat­ing over the past few years, while the in­ter­na­tional p:e is in line with its his­tor­i­cal long-term av­er­age and looks par­tic­u­larly at­trac­tive rel­a­tive to bond yields.

Brooke sug­gests that off­shore eq­ui­ties are now of­fer­ing good value as the out­look for global mar­kets and the econ­omy con­tin­ues to look favourable dur­ing the year ahead. “The big­gest sin­gle short-term risk to the SA eq­uity mar­ket in 2007 re­mains the pos­si­bil­ity of wide­spread

The big­gest sin­gle short-term risk to the SA eq­uity mar­ket re­mains the pos­si­bil­ity of

wide­spread for­eign sell­ing.

for­eign sell­ing, which would not only un­der­mine mar­ket val­ues but ad­versely af­fect the coun­try’s al­ready large cur­rent ac­count deficit, trig­ger­ing a vi­cious cy­cle.” He sug­gests, how­ever, that longer-term prospects for emerg­ing eq­uity mar­kets con­tinue to look favourable given their stronger growth prospects than de­vel­oped economies.

Says Brooke: “With lo­cal mar­ket val­u­a­tions rel­a­tively high at present, ac­tively man­aged, di­ver­si­fied in­vest­ments are likely to pro­vide the most ap­pro­pri­ate risk-re­turn bal­ance for in­vestors over the nearer term.”

Nec­es­sary to ac­tively make the cor­rect tac­ti­cal adjustment. Al­wyn van der Merwe

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