Temper your expectations
South Africa has been a great place to invest in over the past 15 years, with all asset classes delivering returns well above inf lation. This has provided a boost for low equity strategies. Mahesh Cooper, a director at Allan Gray, explains that very long-term historical data and current high asset valuations suggest that investors should prepare themselves for lower real returns going forward.
Allan Gray has been concerned about the level of the South African equity market for some time. “History suggests that at some point the pendulum must swing back the other way. From the current high starting point, we expect that the next 15 years are likely to be far more challenging,” says Cooper. Using data compiled over the past 115 years, Allan Gray looked at the afterinf lation returns of different South African asset classes. It used this data to construct theoretical returns over rolling 10-year periods for a low equity portfolio invested in South African asset classes, comprising one-third equities, one-third bonds and one-third cash. The results are displayed in the graph.
The solid blue line in the graph below shows the returns this portfolio has produced, with the bars representing the contributions from the different asset classes, while the dotted black line shows the average of these 10-year real rolling returns – just over 3% per year above inflation.
Looking at recent history, one can see how returns from all South African asset classes have been well above their long-term averages. However, there have also been periods when this low-equity portfolio has delivered returns below inflation over a 10-year period, sometimes for long periods at a time.
“After a long period of returns well above average [since the early 1990s], returns could be below their long-term average for a period of time,” Cooper cautions. With this in mind, Cooper looks at the positioning of the Allan Gray Stable Fund, a fund dedicated to delivering above-cash returns with a low risk of capital loss.
“When we launched the Stable Fund 15 years ago, we hoped that it would provide clients with returns that were superior to bank deposits. The fund has more than lived up to this, exceeding bank deposits by 5.8% per year since inception,” says Cooper, adding that it is important
DIRECTOR, ALLAN GRAY to remember that this performance is in the past, and that prices today determine returns going forward.
Allan Gray follows a valuation-based investment philosophy and constructs portfolios from the bottom up, looking for assets, such as shares, bonds and property, where the current price is lower than its estimate of their intrinsic or underlying value. The Stable Fund’s portfolio managers start with the objective of preserving clients’ capital and then seek to deliver returns in excess of cash. The fund’s positioning is a direct result of this: shares and other assets are selected based on their attractiveness relative to cash.
Looking at current valuations, it should not come as a surprise that the Stable Fund is cautiously positioned at the moment, and this cautious positioning has hurt relative returns. Cooper explains that, as is the case with all Allan Gray funds, the portfolio managers pay no attention to how the fund’s competitors are invested or the composition of any benchmark, but rather make sure that the fund is positioned to provide downside protection if valuations return to more normal levels.
“In light of current market conditions, we believe that the fund is appropriately positioned to deliver on its objectives and to preserve and grow our clients’ investments over the long term,” concludes Cooper.