Di­ver­si­fi­ca­tion valu­able in testing en­vi­ron­ment

Finweek English Edition - - INSIDE -

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.”

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