As­set Man­ager Re­view

The Star Late Edition - - COMPANIES -

Some are say­ing that we have en­tered an era of low growth and low in­vest­ment re­turns – although the link be­tween eco­nomic growth and in­vest­ment mar­ket re­turns is of­ten dis­puted. What are your views on this? Natalie Phillips, head of in­sti­tu­tional at IN­VESTEC AS­SET MAN­AGE­MENT says the IMF has fore­cast that global growth will re­cover in 2017 to 3.4 per­cent and av­er­age 3.6 per­cent be­tween 2017 and 2021.

While this would be bet­ter than 2016’s es­ti­mated 3.1 per­cent growth rate and is not the sec­u­lar stag­na­tion that some econ­o­mists have warned about, it re­mains be­low the av­er­age of the last 20 years of 3.8 per­cent.

The rea­son for lower growth is a com­bi­na­tion of high debt lev­els, de­te­ri­o­rat­ing de­mo­graph­ics and de­clin­ing pro­duc­tiv­ity. Izak Oden­daal, in­vest­ment strate­gist at OLD MU­TUAL MULTI-MAN­AGERS says Af­ter the 2008-cri­sis, a “new nor­mal” pe­riod of low re­turns was pre­dicted.

While in­ter­est rates have been stuck at or close to record lows, some as­set classes have done well. US re­turned 16 per­cent an­nu­alised re­turns from March 2009 to Jan­uary 2017. Lo­cal eq­ui­ties did well ini­tially, though not so much over the past three years.

The FTSE/JSE All Share In­dex also re­turned around 16 per­cent an­nu­alised since March 2009 in rand (the dol­lar return was much lower but still re­spectable at 11 per­cent per year).

The surg­ing US dol­lar since 2011 means that dol­lar re­turns from out­side the US look poor across the board.

Stud­ies show that rapid eco­nomic growth over the long term does not nec­es­sar­ily lead to fan­tas­tic long-term eq­uity re­turns. Share prices fol­low earn­ings, so what counts is whether faster eco­nomic growth can be trans­formed into prof­its.

It de­pends whether com­pa­nies can cap­ture rea­son­able share of eco­nomic growth (as op­posed to labour and gov­ern­ment) and whether share­hold­ers get a de- cent share in turn (as op­posed to man­age­ment and in­vest­ment bankers).

Eco­nomic growth has in­deed dis­ap­pointed since 2009, but global growth has been more or less in line with the long-term trend.

The dis­ap­point­ment stemmed from the fact that one would ex­pect above-trend growth fol­low­ing the deep global re­ces­sion.

Sev­eral ma­jor economies ex­pe­ri­enced re­ces­sions since 2009 (Europe, Ja­pan, Rus­sia and Brazil), con­tribut­ing to poor in­vest­ment re­turns from these re­gions as re­ces­sions tend to cause prof­its to de­cline or turn into out­right losses.

Part of the prob­lem with the “new nor­mal” think­ing is that it as­sumes that the com­mod­ity su­per­cy­cle and credit-fu­elled boom of 2003-2008 was the “old nor­mal”.

But it is prob­a­bly more cor­rect to view that pe­riod as the out­lier. The crash and im­me­di­ate af­ter­math saw the pen­du­lum swing­ing vi­o­lently the other way.

Now nor­mal­ity ap­pears to be slowly re­turn­ing af­ter years of delever­ag­ing. Global eco­nomic ac­tiv­ity ap­pears to be pick­ing up and the de­fla­tion fears of the past two years are pass­ing.

This has driven mar­ket higher with a bit of help from Pres­i­dent Trump’s ex­pected (but not yet de­liv­ered) poli­cies.

Ul­ti­mately, the start­ing val­u­a­tion is a cru­cial de­ter­mi­nant of re­turns. The like­li­hood of a good return is much higher when an as­set is bought cheaply.

Val­u­a­tions can swing around with shifts in sen­ti­ment, es­pe­cially in the short term. In 2009, eq­uity mar­kets were ex­tremely cheap on de­pressed sen­ti­ment and of­fered a once-in-a-gen­er­a­tion buy­ing op­por­tu­nity.

How­ever, now head­line eq­uity val­u­a­tions are av­er­age for most ma­jor mar­kets, per­haps slightly above av­er­age (with in­ter­est rates well be­low av­er­age) point­ing to mod­er­ate re­turns be­low the longterm norm go­ing for­ward. Kent Grobbe­laar, Head of Port­fo­lio Man­age­ment at STANLIB MULTI-MAN­AGER says the com­pany’s view is that we don’t un­der­stand why there’s a dis­pute.

We be­lieve the rea­son there’s con­fu­sion, is be­cause a key vari­able (val­u­a­tion) is of­ten not in­cluded in the de­bate. The level of the mar­ket is de­ter­mined by both earn­ings and val­u­a­tion.

There­fore strong eco­nomic growth can re­sult in good earn­ings growth, which in the­ory should drive mar­kets higher.

The prob­lem is, if Mr Mar­ket has al­ready fac­tored in the afore­men­tioned, then there clearly won’t be any link.

“We con­cur with the view that we’re in an era of low growth and low in­vest­ment re­turns largely be­cause ex­pec­ta­tions baked into mar­kets, and es­pe­cially the US, are high leav­ing room for dis­ap­point­ment.

“In ad­di­tion, the struc­tural prob­lems of low pro­duc­tiv­ity, bad de­mo­graph­ics and sig­nif­i­cant debt, haven’t gone away and could well be head­winds for the global econ­omy.

“A flat­ter fron­tier would be our base case,” says Grobbe­laar. Neville Ch­ester, se­nior port­fo­lio man­ager at CORONA­TION FUND MAN­AGERS says the state­ment that the link­age be­tween eco­nomic growth and as­set re­turns is weak is cor­rect.

“We have been through a pe­riod post the fi­nan­cial cri­sis where eco­nomic growth was weak but as­set re­turns were gen­er­ally good due to cen­tral bank in­ter­ven­tions and quan­ti­ta­tive eas­ing.

“To as­sess what fu­ture re­turns will look like one has to as­sess what base we are com­ing off.

“In South Africa, you can cur­rently buy a 10-year gov­ern­ment bond yield­ing 8.8%, or you could buy the ma­jor­ity of the mid-cap listed prop­erty stocks with yields in ex­cess of 8%.

“Given that we ex­pect in­fla­tion to av­er­age be­low 6% for this year, there is im­me­di­ately the po­ten­tial for pos­i­tive real re­turns, as­sum­ing a sta­ble po­lit­i­cal en­vi­ron­ment. Sim­i­larly, the JSE has been flat for close to two-and-a-half years.

“If you ex­clude a cou­ple of spe­cific heavy­weight stocks that have out­per­formed, the in­dex would be down over this pe­riod.

“Given this de-rat­ing, we are more op­ti­mistic on the return po­ten­tial for lo­cal stocks than we have been for a num­ber of years,” says Ch­ester. Haakon Kavli, port­fo­lio man­ager & an­a­lyst at PRE­SCIENT IN­VEST­MENT MAN­AGE­MENT says over the last five years, econ­o­mists have de­bated the risk that we have en­tered a global era of “sec­u­lar stag­na­tion”, that is an era of low growth, low in­fla­tion and low re­turns.

“This con­cern may seem strange if one were to look at cur­rent global macroe­co­nomic data.

‘For ex­am­ple, US un­em­ploy­ment is cur­rently at 4.7 per­cent (down from 10 per­cent dur­ing the global fi­nan­cial cri­sis) and the Fed­eral Re­serve keeps pol­icy rates near record low lev­els (0.5-0.75 per­cent).

“The com­bi­na­tion of full em­ploy­ment and mon­e­tary stim­u­lus would nor­mally be ex­pected to boost both growth and in­fla­tion.

“But in­vestors have for a long time stuck to their ex­pec­ta­tions of low growth, low in­fla­tion and low re­turns.

“This view was most in­tensely priced six months ago, when bond mar­kets re­flected in­fla­tion ex­pec­ta­tions of 1.5 per­cent over the next 10 years in the US. Yields on US 10 year bonds were at 1.4 per­cent; and Ger­man and Ja­panese 10 year yields were neg­a­tive.

“With less than 0 per­cent gain on a ten year in­vest­ment, one can surely say ex­pected in­vest­ment re­turns are low.

“Sur­pris­ingly, with Trump’s vic­tory this sec­u­lar stag­na­tion hy­poth­e­sis was quickly for­got­ten. US bond yields jumped back above 2.5 per­cent and eq­ui­ties rallied in ex­pec­ta­tion of im­proved com­pany prof­its.

“In­fla­tion ex­pec­ta­tions jumped back to the Fed’s tar­get of 2 per­cent. In­vestors who for years had thought sec­u­lar stag­na­tion was im­mune to pol­icy, driven by un­stop­pable de­mo­graphic forces, sud­denly changed their minds overnight.

“Our view is that mar­kets have over­priced the im­pact of a Trump pres­i­dency. Over­all we see a rather ro­bust global econ­omy, where growth is slow but sta­ble and ex­pected in­vest­ment re­turns re­main low due to stretched val­u­a­tions.

“Our es­ti­mates sug­gest this trend will con­tinue in 2017. As­set al­lo­ca­tion is dif­fi­cult in this en­vi­ron­ment.

“Eq­ui­ties come with con­sid­er­able risk and of­fer lim­ited re­al­is­tic up­side. Lo­cal bonds of­fer some risk com­pen­sa­tion but are ex­posed to po­lit­i­cal risk, rand de­pre­ci­a­tion and in­fla­tion sur­prises.

“In to­tal we there­fore view cor­po­rate credit to be the most at­trac­tive driver of risk ad­justed re­turns in 2017,” says Kavli. Kyle Hulett, deputy chief in­vest­ment of­fi­cer and head of multi-as­set class at ARGON AS­SET MAN­AGE­MENT says it is true that the link be­tween low GDP growth and low eq­uity in­vest­ment re­turns is un­clear.

How­ever, it is im­por­tant to un­der­stand why growth is ex­pected to be low; and to un­der­stand the mon­e­tary poli­cies that have been im­ple­mented to ad­dress low growth and how these af­fect in­vest­ment re­turns.

“Eco­nomic growth is ex­pected to be low due to a com­bi­na­tion of fac­tors that have not been seen be­fore in Western his­tory. Only Ja­pan has ex­pe­ri­enced this com­bi­na­tion of growth head­winds that in­clude an age­ing pop­u­la­tion, fall­ing pro­duc­tiv­ity and peak­ing debt lev­els.

“These forces have cre­ated a sav­ings sur­plus that has pushed in­ter­est rates down to new lows. In some coun­tries in­ter­est rates are even neg­a­tive.

“This, and the quan­ti­ta­tive eas­ing poli­cies that cen­tral banks have de­ployed to stim­u­late economies have in turn dis­torted as­set class val­u­a­tions.

“So, it is not only the low growth that af­fects in­vest­ment re­turns, but also the his­tor­i­cally high val­u­a­tions that are a con­se­quence of quan­ti­ta­tive eas­ing,” says Hulett.

“Age­ing pop­u­la­tions mean an in­crease in re­tirees, which pushes eq­uity val­u­a­tions down. Fall­ing pro­duc­tiv­ity af­fects com­pany mar­gins and there­fore their earn­ings.

“Peak debt lev­els mean greater debt ser­vic­ing re­quire­ments for con­sumers, cor­po­rates, and gov­ern­ments.

“These fac­tors all de­crease de­mand and re­duce pric­ing power, which again af­fects rev­enues and mar­gins.

“So, while low growth in and of it­self may or may not af­fect in­vest­ment re­turns di­rectly, the cur­rent causes of low ex­pected growth rates do af­fect eq­uity in­vest­ment re­turns neg­a­tively on their own.” Peter Brooke, Head of MacroSo­lu­tions bou­tique at OLD MU­TUAL IN­VEST­MENT GROUP says the firm has been pro­po­nents of a “low return world” for some time now and this re­mains the case, pre­dom­i­nantly driven by val­u­a­tions.

How­ever, a ray of light comes from the lo­cal eq­uity mar­ket which has been go­ing side­ways for the last cou­ple of years.

This has re­sulted in some val­u­a­tions be­ing re­freshed and we have upped our long-term real return from South African shares.

“On our five year in­vest­ment time hori­zon, we now think it is pos­si­ble to de­liver a real return of 4 per­cent on a bal­anced fund. While this is lower than we have de­liv­ered his­tor­i­cally, it is bet­ter than what has been avail­able in the last cou­ple of years.

“We also ex­pect cash yields to fall, mean­ing savers can no longer sit on the side-lines.” Dun­cas Ar­tus, port­fo­lio man­ager at AL­LAN GRAY says the level of re­turns that a port­fo­lio can pro­duce over time de­pends on the start­ing val­u­a­tions of the as­sets it is in­vested in, rather than the level of eco­nomic growth.

There is lit­tle cor­re­la­tion be­tween real eq­uity re­turns and per capita GDP growth over the long term. With global in­ter­est rates still at his­tor­i­cally low lev­els, one has to ex­pect that ab­so­lute re­turns from fixed in­come will be low.

The low level of in­ter­est rates has driven some eq­uity mar­kets, such as the US, which has gen­er­ated strong re­turns since the cri­sis. How­ever, val­u­a­tion lev­els now ap­pear stretched, in our view.

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