Balanced funds of­fer­ing promis­ing re­turns

South African as­sets have yielded dis­ap­point­ing re­turns of late, but turn­ing to cash is not ad­vis­able. For medium- to longer-term in­vestors, di­ver­si­fied port­fo­lios like balanced funds are a good op­tion.

Finweek English Edition - - Fundfocus - By Hamil­ton van Breda Hamil­ton van Breda

de­spite the broadly dis­ap­point­ing re­turns from South African as­sets in re­cent times, par­tic­u­larly eq­ui­ties, at Pru­den­tial our anal­y­sis shows that many as­sets are cur­rently val­ued to de­liver promis­ing in­fla­tion-beat­ing re­turns over the medium term. There­fore in­vestors have good rea­son not to turn to cash, but in­stead to have faith in di­ver­si­fied port­fo­lios like balanced funds. Lo­cal eq­ui­ties have un­der­per­formed their longer-run av­er­ages over the past three years to 30 June 2018, fall­ing short of lo­cal bonds and cash. SA eq­ui­ties have re­turned only 4% p.a. and SA listed prop­erty only 0.9% p.a., com­pared to 7.8% p.a. from SA bonds and 7.3% from SA cash, while in­fla­tion has been 5.3% p.a. over the same pe­riod. This muted in­vest­ment per­for­mance has pushed re­turns from multi-as­set funds be­low their ex­pected longer-term av­er­age.

In­vestors should know that these re­turns are not the norm: South African eq­ui­ties con­sis­tently pro­duce higher re­turns than cash the ma­jor­ity of the time, re­ward­ing in­vestors for the ex­tra risk in­volved.

Multi-as­set funds like the Pru­den­tial Balanced Fund aim to cap­ture this un­der­ly­ing longer-term per­for­mance, com­bin­ing the po­ten­tial of higher re­turns from eq­ui­ties and listed prop­erty with lower-risk bonds and cash to pro­vide solid in­fla­tion-beat­ing re­turns with some volatil­ity, but also some down­side pro­tec­tion.

The graph de­picts the to­tal re­turns pro­duced by the Pru­den­tial Balanced Fund ev­ery year from 1999 (shown by the gold bars), for an av­er­age an­nual to­tal re­turn of 14.0%. The fund out­per­formed cash sub­stan­tially, which re­turned an av­er­age of 7.7% (shown by the green dots). It also beat cash in 14 out of the 18 years, 78% of the time.

In de­liv­er­ing this per­for­mance, the fund also ex­pe­ri­enced tem­po­rary neg­a­tive re­turn pe­ri­ods ev­ery year (the max­i­mum in­tra-year down­turn is shown by the red dots). This largely re­flects its volatile eq­uity hold­ings. It recorded its largest in­tra-year draw­down at -24% dur­ing the global fi­nan­cial cri­sis in 2007, and saw a tem­po­rary in­trayear fall of at least 2% ev­ery year.

De­spite this volatil­ity, how­ever, the fund man­aged to de­liver pos­i­tive re­turns in each of the 18 cal­en­dar years apart from two. If in­vestors are aware of this volatil­ity and know they need to tol­er­ate it in or­der to ben­e­fit from strong re­turns over time, they can bet­ter re­sist the temp­ta­tion to move more of their money to cash.

Go­ing for­ward, we believe balanced funds should per­form bet­ter over time, based on cur­rent as­set class val­u­a­tions and our fund po­si­tion­ing. The Pru­den­tial Balanced Fund is over­weight global eq­ui­ties gen­er­ally, where the as­set class has the po­ten­tial to de­liver an es­ti­mated nom­i­nal re­turn of 12.6% p.a. over the medium term.

De­spite the long global eq­uity rally, cer­tain re­gions and sec­tors re­main at­trac­tively priced: for ex­am­ple, the fund is over­weight Ger­many, Ja­pan, South Korea, China and In­done­sia, while we are un­der­weight rel­a­tively ex­pen­sive US eq­ui­ties. We also believe global in­vest­ment-grade cor­po­rate bonds of­fer good yields com­pared to their risk, but we are avoid­ing de­vel­oped mar­ket sovereign bonds as their yields re­main too low.

The Pru­den­tial Balanced Fund is also over­weight South African eq­ui­ties, where val­u­a­tions are rel­a­tively at­trac­tive, be­ing priced to pro­duce a re­turn of around 12.9% p.a. over the medium term. The fund holds com­pa­nies with sub­stan­tial ex­po­sure to strong global growth, in­clud­ing re­sources com­pa­nies like An­glo Amer­i­can, BHP, Sappi and Exxaro, as well as Naspers* and Bri­tish Amer­i­can To­bacco. We also like fi­nan­cial shares in­clud­ing Old Mu­tual, FirstRand, Stan­dard Bank and Bar­clays Group Africa which have of­fered low val­u­a­tions with rel­a­tively high div­i­dend yields. Ad­di­tion­ally, the fund is broadly un­der­weight re­tail stocks, given the fi­nan­cial stresses faced by SA con­sumers.

Be­sides eq­ui­ties, the Pru­den­tial Balanced Fund has a moder­ately over­weight hold­ing in SA gov­ern­ment bonds, where cur­rent val­u­a­tions in­di­cate a re­turn of around 9.7% over time. We pre­fer longer-dated bonds for the higher yields on of­fer. How­ever, we are neutral in listed prop­erty and in­fla­tion-linked bonds.

Even though listed prop­erty has fallen sharply in value so far this year, this is due largely to the de­cline in the share prices of the Re­silient group of four prop­erty com­pa­nies. Ex­clud­ing these com­pa­nies, the as­set class is priced some­what ex­pen­sively – mod­estly above its fair value range – and the sec­tor faces risks from higher in­fla­tion, ris­ing in­ter­est rates and low growth. Yet val­u­a­tions for listed prop­erty sug­gest a re­turn of around 14.4% p.a. in the next three to five years.

Fi­nally, prospec­tive SA cash re­turns com­pare un­favourably, the low­est of the lo­cal as­set classes at 7.3% p.a. over time, and barely ahead of in­fla­tion at around 6.0% year-on-year. So for medium- to longer-term in­vestors, switch­ing to cash now is very un­likely to give you bet­ter re­turns. Some pa­tience is re­quired: we believe that the cur­rent port­fo­lio po­si­tion­ing of the Pru­den­tial Balanced Fund will al­low it to con­tinue to pro­duce strong re­turns that beat in­fla­tion over the medium term. ■

is head of re­tail sales at Pru­den­tial In­vest­ment Man­agers.

*fin­week is a pub­li­ca­tion of Me­dia24, a sub­sidiary of Naspers.

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