Diversification valuable in testing environment
David Knee, head of f i xed in c o me a t Pr ud e nt ia l Investment Managers, shares the fairly widespread view that investment returns in 2015 are likely to be lower than last year, but he dismisses any notion of a calamity.
He points to further quantitative easing coming through from Europe and Japan, lower interest rates in many emerging markets, fairly strong US growth and the drop in the oil price and other commodities fuelling expectations for lower inflationary pressures and stronger consumer spending in the months ahead.
“Lower inf lation has come at an opportune moment for the South African economy. With consumer price inflation projected to remain well below the South African Reserve Bank’s (Sarb’s) 6% upper target limit this year, our interest rates may not rise as quickly or as steeply as was previously expected.
“This reinforces our view of lower interest rates for longer, which should help the economy improve in 2015, and in turn support corporate earnings growth, despite the negative impact of electricity shortages. We may not even see a hike by the Sarb this year – although this will depend on how the Federal Reserve’s monetary policy evolves, as well as the rand’s exchange rate. Lower inf lation also boosts real investment returns for investors,” he says.
Against this, however, he notes that global growth as a whole remains weak. Conditions in Japan and Europe are sputtering; Chinese growth has slowed to its lowest level year-on-year in five years; and most leading emerging markets, including Russia, are struggling to recover.
According to 2014 data from the Association for Savings and Investment South Africa (ASISA), investors have responded to the uncertain conditions by continuing to prefer multi-asset balanced- type funds, Knee says, which offer lower risk through their diversification but can still provide inflation-beating returns.
“For example, the Prudential Balanced Fund returned a strong 11.7% [after fees] in 2014, beating the 10.9% [before fees] of the FTSE/ JSE All Share Index, a performance not likely to be repeated in the new year. The fund benefitted from its holdings in listed property and offshore assets [equities and bonds] over the period,” he says.
Knee says that in this environment, his investment house’s global asset allocation continues to favour equities over bonds or cash, and global equities over local equities, as global equities remain more attractively valued than SA equities on measures like price-to-earnings and priceto-book ratios.
“In our higher ret urn-t argeting multi-asset funds we are very near our maximum permitted 25% weighting in offshore markets with equities forming the bulk of this. From a long-term valuation perspective, developed market equities [such as Germany] still appear to be fairly valued to somewhat cheap, both in absolute terms and relative to cash and bonds.
“Emerging market equities, although offering even better value, generally present higher r i sks. In our f und positioning, we are overweight Germany and Italy, and underweight commodity producers like Australia and Canada,” he explains.
Prudential also recently reduced its overweight to Korean equity in the wake of its concern over the rapid depreciation of the Japanese yen against the Korean won, which in t urn led it to reduce its earnings expectations for Korean companies given that the two countries compete closely in the same markets.
Its house view is that SA equities are fair to slightly expensive, and so it remains neutral on this asset class. However, potential real returns are considered attractive compared to other asset classes.
It favours certain financial stocks over expensive industrials. Top overweight positions include Old Mutual, Investec and British American Tobacco, while top underweights are Steinhoff, Remgro and Sanlam.
After having moved to overweight in listed property in the second quarter of last year followed by considerable outperformance, i n l ate 2014 t he investment house decided to reduce its overweight position somewhat, but remains moderately overweight.
“Although valuations now look less attractive relative to longer-dated bonds than they did, property is still expected to deliver inf lation-beating distribution growth,” says Knee.
Prudential also recently reduced its long duration position in nominal bonds, following the strong rally last year that brought yields to more expensive levels. This, incidentally, has been in contrast to some other major players in the market who have increased their weighting.
“Our view is that bonds are on the expensive side of fair, and our preference has been to sell them rather than hold them. Since you have no way of knowing when the market is going to turn, for us that means we generally end up selling and buying early, and miss the market’s tops and bottoms. We scale into an asset when it gets cheaper, and we get out when it becomes more expensive.”