High-qual­ity global equities and lo­cal bonds are good prospects

Muted per­for­mance means bet­ter val­u­a­tions for JSE shares but care­ful se­lec­tion is vi­tal

Business Day - - THE BOTTOM LINE - Sumesh Chetty and Dar­ren Jocum ● Chetty is a port­fo­lio man­ager, and Jocum an an­a­lyst, at In­vestec As­set Man­age­ment.

Last year proved to be the an­tithe­sis of 2017. Whereas in 2017 al­most ev­ery as­set class glob­ally gen­er­ated a pos­i­tive re­turn, 2018 ended with al­most ev­ery as­set class in the red.

Other than cash, there was nowhere to hide: de­vel­oped mar­ket equities, emerg­ing-mar­ket equities, com­modi­ties and global credit, to men­tion a few, gen­er­ated neg­a­tive US dol­lar re­turns. It was the first neg­a­tive year for global eq­uity mar­kets since the fi­nan­cial cri­sis, de­spite the fis­cal stim­u­lus in the US.

The muted re­turns gen­er­ated by the JSE all share in­dex over the past few years, al­though not al­to­gether sur­pris­ing given the stretched val­u­a­tions at the be­gin­ning of this pe­riod, are hard to stom­ach.

Over the past three years to the end of De­cem­ber, the to­tal re­turn from the all share was a mere 4.3%; over five years the to­tal re­turn was only 5.8%. Equities are com­monly re­ferred to as “real” as­sets, mean­ing they are sup­posed to pro­vide an in­fla­tion-beat­ing re­turn and are the main weapon in the arse­nal of an in­vestor seek­ing growth in ex­cess of in­fla­tion.

How are in­vestors sup­posed to beat in­fla­tion if equities are not up for the job?

The an­swer lies in re­mem­ber­ing that eq­uity re­turns do not come in a straight line. Mar­kets fol­low cy­cles. The strong dou­ble-digit re­turns that in­vestors had come to ex­pect from the all share were never sus­tain­able in per­pe­tu­ity. Val­u­a­tions had be­come stretched and lower re­turns were in­evitable.

There is a sil­ver lin­ing. The sub­dued re­turns over the past few years have re­sulted in more at­trac­tive val­u­a­tions for many JSE-listed stocks and buy­ing op­por­tu­ni­ties are emerg­ing.

While we ac­knowl­edge that eq­uity mar­kets are at their low­est lev­els in years, this alone does not merit an in­crease in eq­uity ex­po­sure. Eq­uity mar­kets are not cheap in ab­so­lute terms (they are still trad­ing above their long-term av­er­ages).

Ex­pec­ta­tions of earn­ings growth are still high and ap­pear some­what dis­con­nected from eco­nomic re­al­ity. Com­bined with an en­vi­ron­ment of tight­en­ing liq­uid­ity, slow­ing growth and mul­ti­ple risk events, stock se­lec­tion be­comes para­mount.

The best op­por­tu­nity, in our view, re­mains high-qual­ity global equities that are gen­er­at­ing high and sus­tain­able re­turns on in­vested cap­i­tal.

In terms of in­di­vid­ual stocks, we have sought a bal­ance be­tween old-econ­omy sta­ples and newer, higher-growth op­por­tu­ni­ties. What these busi­nesses have in com­mon, apart from their prodi­gious cash gen­er­a­tion and ex­cep­tional re­turns on cap­i­tal, is an abil­ity to grow with a lower de­pen­dence on the eco­nomic cy­cle than the av­er­age busi­ness.

Given their prospects, these busi­nesses also con­tinue to trade cheaper than the mar­ket and proved far more re­silient over 2018.

In a sim­i­lar vein, we have sought out lo­cally listed global busi­nesses with lit­tle de­pen­dence on a weak SA econ­omy.

Lo­cally, the best op­por­tu­nity in our view re­mains SA gov­ern­ment bonds, of­fer­ing more at­trac­tive risk-ad­justed re­turns than SA equities. At yields above 9%, these in­stru­ments of­fer far higher risk-ad­justed re­turn po­ten­tial than the re­tail, bank­ing and prop­erty sec­tors.

On a 10-year ba­sis, SA gov­ern­ment bonds are of­fer­ing an ex­pected 4% real yield to pa­tient in­vestors. Our bond ex­po­sure re­mains pru­dent: lower-du­ra­tion, higher-qual­ity in­stru­ments, with ex­po­sure bal­anced against off­shore hold­ings to limit the po­ten­tial for loss.

We main­tain a bal­ance of ex­po­sures in our port­fo­lios, which of­fers pro­tec­tion against a range of po­ten­tial out­comes. With risk at the fore and liq­uid­ity be­ing drained away, we do not be­lieve that it is ap­pro­pri­ate to po­si­tion our port­fo­lios for a par­tic­u­lar out­come.

As al­ways, we re­main un­wa­ver­ing in our com­mit­ment to grow­ing cap­i­tal in a ju­di­cious and dis­crim­i­nate man­ner.

THE SUB­DUED RE­TURNS OVER THE PAST FEW YEARS HAVE RE­SULTED IN MORE AT­TRAC­TIVE VAL­U­A­TIONS FOR MANY JSE STOCKS

/Bloomberg

Buy­ing op­por­tu­ni­ties: The to­tal re­turn from the JSE’s all share in­dex was just 4.3% over the past three years, but mar­kets are cycli­cal and eq­uity re­turns do not come in a straight line.

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