You’ll need more than local assets to deliver the goods this time round
The factors that boosted the returns of most local asset classes over the past decade are unlikely to be present over the next 10 years. Laura du Preez reports on where South African and offshore markets may be headed and what this means for your investme
Investors have enjoyed excellent real (after-inflation) returns from most local asset classes over the past decade, but you should expect a much slower upward grind from these markets in the decade ahead.
This means you will have to save more, and you will not be able to rely on a bull market to bail you out if you have not saved enough for your retirement, because the big up-anddown market swings of recent years are unlikely to be repeated soon, Peter Brooke, the head of the Macro Strategy Investments boutique at Old Mutual Investment Group, says. (See “What you can do in the face of lower local returns”.)
Meanwhile, the past decade was a lost one for local investors in offshore assets, but, once again, you should not expect more of the same in the decade ahead (see “Reduced debt burden is key to sustained bull run in global equities”).
Brooke says over the decade to the end of last year, investors earned an average real return of 9.8 percent a year from local equities, 17.7 percent a year from listed property and 6.1 percent a year from bonds.
Brooke says these were excellent returns, and they resulted in a good perfor mance by balanced funds (asset allocation funds that move between equities, bonds, property and cash). The domestic asset allocation prudential medium equity funds, for example, had an average annual real return of 12.9 percent over the past 10 years.
But you should not expect the same in the decade ahead, because the returns of the past 10 years were boosted by falling inflation, lower interest rates and high gross domestic product (GDP) growth – factors that are unlikely to characterise the next 10 years, Brooke says.
The past decade was one of the best for South Africa’s GDP growth since the 1960s, because the government invested in infrastructure and consumer spending grew, he says.
In addition, local listed companies benefited from the growth in emerging markets – such as China, India, Brazil and Russia – and a boom in commodities.
Listed companies also benefited from a growth in real earnings of about seven percent a year over the past decade, Brooke says.
But the growth in earnings will be flatter in the decade ahead, he predicts, with real returns from equities likely to be about 6.5 percent a year over the next five years.
Brooke says although the big investment theme of China and faster growth from emerging markets is set to continue to benefit commodity producers in South Africa and elsewhere, its effect is not likely to be as pronounced.
“Real commodity prices nearly tripled in the past decade, and we can’t expect a repeat of this phenomenon,” he says.
He also does not expect South Africa’s GDP to grow as fast in future because of slower growth in the developed economies due to a withdrawal of the money central banks have made available during the credit crisis.
South Africa’s growth will also be hampered by capacity constraints, such as electricity and education, he says.
Brooke says falling inflation helped to boost the bond market, but inflation and interest rates are likely to be flatter over the next five years. Hence Brooke expects a more pedestrian real return of three percent a year from government bonds over the next five years rather than the annual 6.1 percent that bonds earned over the past decade.
Brooke says he expects an annual retur n of 6.5 percent from local listed property over the next five years. Listed property, which was buoyed by falling interest rates, was the best-performing asset class of the past decade.
He says although the recent re-rating in listed property prices has lowered expected returns, the income earned by listed property will continue to grow.
There could be greater demand for property in the future because of the lack of new building projects approved in the economic downturn, Brooke says.
Returns from local bonds, property and equities are likely to be more boring in the decade ahead. But you will still be better off investing in a portfolio that is exposed to those asset classes in line with your appetite for risk rather than in cash, Brooke says.
He expects a real return from cash of about three percent a year over the next five years, because he believes the lower interest rate environment achieved by the Reserve Bank’s monetary policy during the past decade is here to stay. “The phenomenal cash returns of the 1990s will not be repeated.”
Prudential Portfolio Managers is also of the view that over the next decade investors in the South African market are unlikely to experience the same degree of outperformance relative to listed assets in the United States given how those assets are priced currently.
Chris Wood, a portfolio manager for the Prudential Equity Fund, says during the past decade the rand enjoyed an extended period of strength against the US dollar that boosted the US dollar returns of South African equities relative to those achieved by an investment in the Standard & Poor’s 500 index. This was because the rand started the past decade at a relatively weak level against the US dollar.
Prudential does not expect the trend of rand strength to persist during the coming decade.