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.
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.