When the bulls stop running
Diversified asset allocation funds the flavour of the month
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