Find­ing real re­turns: Hard work awaits

With high as­set val­u­a­tions and slow growth in many mar­kets, it will be more dif­fi­cult than be­fore to achieve in­fla­tion-beat­ing re­turns.

Finweek English Edition - - FUNDFOCUS - David Knee is chief in­vest­ment of­fi­cer at Pru­den­tial In­vest­ment Man­agers.

as2016 draws to a close, a look at as­set val­u­a­tions across the globe tells us that, go­ing for­ward into the new year, re­turns that sub­stan­tially beat in­fla­tion are likely to be harder to come by for South African in­vestors than they have been in the past few years.

Not only is global growth slow, but many as­sets are ex­pen­sive com­pared to their long-term past. This means that in­vest­ment man­agers will have to search even harder for at­trac­tive sources of real re­turns, while be­ing ever-vig­i­lant of the risk in­volved.

So how are we po­si­tion­ing our multi-as­set funds to earn the best pos­si­ble re­turns over the medium term? From a global per­spec­tive, we believe that South African bonds are cheap com­pared to their long-term fair value, and of­fer good prospec­tive re­turns. This fol­lows their weak­ness stem­ming from el­e­vated po­lit­i­cal risk (in­ci­dents such as Nenegate and threats to the fi­nance min­is­ter’s po­si­tion), as well as the risk of a credit rating down­grade, both be­ing priced into yields. Rel­a­tively high yields of around 9% (for the 10-year govern­ment bond) of­fer at­trac­tive real re­turns on a risk/ re­ward ba­sis.

The eas­ing of in­fla­tion and di­min­ished like­li­hood of fur­ther in­ter­est rate hikes have im­proved – to an ex­tent – the out­look for in­ter­est-rate­sen­si­tive as­sets like bonds and listed prop­erty, de­spite very slow eco­nomic growth.

Lo­cal listed prop­erty, with a for­ward dis­tri­bu­tion yield of over 7% and (con­ser­va­tive) long-term po­ten­tial dis­tri­bu­tion growth of over 5%, is priced to de­liver low­dou­ble-digit re­turns in the re­gion of 12% in the medium term (in the ab­sence of a mar­ket de-rating). This is well above in­fla­tion, and we con­sider it at­trac­tively priced rel­a­tive to in­fla­tion-linked bonds (ILBs). As such, we are mod­estly over­weight both SA bonds and listed prop­erty (to a lesser ex­tent) in the Pru­den­tial In­fla­tion Plus and Bal­anced Funds.

South African eq­ui­ties, mean­while, have been trad­ing at lev­els near (or slightly higher than) their long-term fair value. As such, we are neu­trally weighted in SA eq­ui­ties in our multi-as­set port­fo­lios cur­rently. We are un­der­weight ex­pen­sive global heavy­weights like Aspen and Stein­hoff.

We also re­tain our de­fen­sive po­si­tion­ing in re­sources, be­ing un­der­weight spe­cialised min­ers like An­gloGold Ashanti and Im­pala Plat­inum, while pre­fer­ring di­ver­si­fied min­ers (like An­glo Amer­i­can) and non-min­ing shares like Sappi. We are also over­weight fi­nan­cial stocks, in­clud­ing Old Mu­tual and Bar­clays Group Africa, whose share prices have come un­der pres­sure.

For global eq­ui­ties, our port­fo­lios are cur­rently neu­trally weighted gen­er­ally and com­pared to SA eq­ui­ties. This fol­lows a run-up in global share prices in the lat­ter part of this year even as com­pany earn­ings growth has been vir­tu­ally flat, re­sult­ing in a de­te­ri­o­ra­tion in global eq­uity val­u­a­tions.

More global in­vestors have been seek­ing higher re­turns from the US and other de­vel­oped eq­uity mar­kets, forced to take higher risk in the face of record-low yields from global sov­er­eign bond and money-mar­ket in­stru­ments. Some Euro­pean mar­kets, where con­cerns over growth have kept share prices un­der pres­sure, do of­fer value.

At the same time, cer­tain emerg­ing­mar­ket eq­ui­ties are also val­ued at­trac­tively, but we are very se­lec­tive in our ex­po­sure as many also come with rel­a­tively high AS­SET CLASS FUND PO­SI­TION­ING ON 31 OCT. 2016 Global eq­uity Global fixed in­come Global cash SA eq­uity SA listed prop­erty SA fixed in­come SA ILBs SA cash Neu­tral Un­der­weight Over­weight Neu­tral Over­weight Over­weight Un­der­weight Un­der­weight risks. In­dia is a mar­ket that we like. In the Pru­den­tial Bal­anced Fund we are near the 25% max­i­mum ex­po­sure al­lowed for off­shore eq­uity.

With many de­vel­oped economies of­fer­ing neg­a­tive or record-low yields on their govern­ment bonds, we are avoid­ing these as­sets, pre­fer­ring to hold both in­vest­ment­grade and high-yield cor­po­rate bonds which have of­fered solid re­turns so far this year. De­spite the re­cent rally in cor­po­rate bond yield spreads ver­sus US Trea­suries, they re­main around their long-term his­toric av­er­ages and there­fore close to fair value. At the same time, our port­fo­lios are un­der­weight du­ra­tion and over­weight cash to pro­tect against the in­creas­ing risk of in­ter­est rate hikes.

In con­clu­sion, we would cau­tion in­vestors to ex­pect con­tin­ued volatil­ity in fi­nan­cial mar­kets in the new year, given the un­cer­tainty in­tro­duced by Don­ald Trump as US pres­i­dent, a pos­si­bly ac­cel­er­ated US in­ter­est rate hik­ing path, and other fac­tors like Brexit and slow growth in ma­jor economies (and in South Africa). With many as­set val­ues el­e­vated com­pared to their long-term his­to­ries it will be dif­fi­cult for re­turns to mea­sure up to their longer-term per­for­mance.

With many de­vel­oped economies of­fer­ing neg­a­tive or record­low yields on their govern­ment bonds, we are avoid­ing these as­sets, pre­fer­ring to hold both in­vest­ment­grade and high-yield cor­po­rate bonds.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.