Con­sid­er­ing the im­pact of ris­ing in­ter­est rates on our port­fo­lios

Finweek English Edition - - PSG -

We f i nd our­selves i n ex­tra­or­di­nary times. Ninety per­cent of the in­dus­tri­alised global econ­omy is sub­ject to near-zero in­ter­est rate pol­icy, and cen­tral banks have adopted ex­tremely ac­com­moda­tive mon­e­tary pol­icy to counter the ef­fects of the global f inan­cial cri­sis and the un­wind­ing of a debt ‘su­per-cy­cle’. As a re­sult of th­ese in­ter­ven­tions, we find most in­ter­est rates in de­vel­oped mar­kets, both short and long term, at multi-gen­er­a­tional, or, in some cases, all-time lows.

The con­se­quence of very com­pressed yields on cash, gov­ern­ment bills, trea­suries and in­vest­ment grade credit is that in­vestors re­quir­ing in­come from their in­vest­ment port­fo­lio have been forced fur­ther out on the risk curve, into things like prop­erty, high yield credit, eq­ui­ties and emerg­ing mar­kets. To main­tain yields, in­vestors have had to move into riskier as­sets and se­cu­ri­ties.

The key ques­tion that in­vestors should be ask­ing them­selves to­day is: am I be­ing com­pen­sated for the risk that I am tak­ing? In other words, am I be­ing com­pen­sated via cur­rent yield and sus­tain­able fu­ture growth thereof for the risk that, at some stage, the world econ­omy re­verts to look­ing more nor­mal?

Re­mem­ber that in this world of ul­tralow yields, a small pos­i­tive in­crease in inf la­tion ex­pec­ta­tions could have a pro­nounced im­pact on as­set prices in some ar­eas. For ex­am­ple, Should G7 bond yields revert to their 10-year av­er­age, in­vestors in those bonds, typ­i­cally the low­est risk in­vestors, would suf­fer an 18% loss. If the price-to-earn­ings (P/E) ra­tio of the FTSE/JSE INDI 25 In­dex were to revert to its 10-year av­er­age, the cap­i­tal loss would be in the or­der of 33%. The list goes on. (Sources: Bloomberg, I-Net, PSG As­set Man­age­ment.)

Our port­fo­lios are con­structed in a bot­tom-up fash­ion. We care­fully an­a­lyse all the se­cu­ri­ties across the yield spec­trum (from cash to high risk eq­ui­ties) and de­cide whether the spe­cific se­cu­ri­ties meet our re­quired rate of re­turn, given our view on the un­der­ly­ing risk of the se­cu­rity. We like to in­vest with a mar­gin of safety and are happy to walk away from in­vest­ment op­por­tu­ni­ties where we think that it is pos­si­ble that our clients could lose money. Our sum­ma­tion of the cur­rent con­di­tions on fi­nan­cial mar­kets is that an in­vest­ment into some of the tra­di­tion­ally lower risk as­set classes (gov­ern­ment bonds, prop­erty and low beta eq­ui­ties) car­ries a high like­li­hood of cap­i­tal loss and most of th­ese as­sets are over­priced. Ac­cord­ingly, we do not own gov­ern­ment bonds, prop­erty and bond-like eq­ui­ties.

Within eq­ui­ties, we have been find­ing sig­nif­i­cantly fewer op­por­tu­ni­ties to in­vest

FUND MANAGER, PSG AS­SET MAN­AGE­MENT in higher qual­ity busi­nesses at rea­son­able val­u­a­tions on the JSE. As a re­sult, our port­fo­lios are not fully in­vested in do­mes­tic eq­ui­ties. Our do­mes­tic funds have utilised the full ex­tent of their man­dates to buy at­trac­tively priced global busi­nesses with qual­ity fran­chises.

The re­sult of hav­ing very l imited ex­po­sure to du­ra­tion as­sets and be­ing less than fully in­vested in eq­ui­ties is that our multi-as­set port­fo­lios sit with rel­a­tively high lev­els of cash, which would be­come larger con­trib­u­tors to port­fo­lio re­turns as in­ter­est rates rise. Cash also pro­vides f ire­power to be em­ployed if val­u­a­tions nor­malise and op­por­tu­ni­ties arise to buy at­trac­tively priced higher du­ra­tion as­sets. We think the value of cash at this stage of the in­vest­ment cy­cle is both at­trac­tive and un­der­ap­pre­ci­ated.

Now i s t he t i me f or i nvestors to con­sider whether they are be­ing com­pen­sated for the risk they are tak­ing in their port­fo­lios. We are com­fort­able that we are not putting our clients’ cap­i­tal at risk by chas­ing over­priced as­sets and se­cu­ri­ties. We take f ur­ther com­fort from the fact that we can still find good op­por­tu­ni­ties in very spe­cific as­sets and se­cu­ri­ties both at home and abroad.

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