Financial Mail - Investors Monthly
Expect volatility
A balance between offence and defence is necessary as some safe havens have lost their lustre, writes Pedro van Gaalen
Capital preservation and liquidity become critical investment objectives during periods of market volatility. In their flight from risk, investors traditionally flock to conventional safe-haven assets to realise these benefits.
“A safe-haven asset typically holds its value because it is backed by a physical asset and serves as a store of value. These attributes can provide more certainty in returns,” says Kim Rassou, portfolio manager at Old Mutual Wealth Tailored Fund Portfolios.
Consequently, safe-haven assets tend to rise in value during a crisis but typically return to pre-crisis levels when risks dissipate. This scenario played out in the wake of the pandemic’s economic impact after reserve banks aggressively cut interest rates.
“The price rocketed as investors bought gold to offset the dollar’s loss in value due to the economic stimulus packages in the US, which will drive up inflation, accompanied by the precipitous drop in interest rates,” says Rassou.
“And dollar weakness is good for gold, which means it will likely sustain its price above pre-pandemic levels for some time.”
However, investment trends during the height of the pandemic-induced sell-off suggest that the established safe-haven investment approaches and the traditional assets that investors turn to in times of crisis lost some of their lustre.
“For example, the gold buying frenzy failed to reach the same levels witnessed during the global financial crisis because bitcoin offered an alternative option during the Covid crisis,” says Rassou.
“And, while the value in an asset like gold is more durable, it does not pay dividends.”
More tellingly, investors who fled equities for foreign cash and gold amid the market carnage missed the market recovery and locked in their losses.
For these reasons, Rassou says Old Mutual Wealth Tailored Fund Portfolios retained its preference for equities through the crisis.
“We remained fully invested in the market and followed our asset allocation while making tactical tilts.”
While markets have since regained some stability, the dynamic remains fluid. Accordingly, Duane Cable, head of SA Quality at Ninety One Asset Management, cautions against risk-on bravado.
“The current environment, characterised by record-low interest rates and unprecedented stimulus, is favourable for risk-taking. The current consensus is that 2021 will be good for risk assets.”
While these conditions would usually favour an offensive strategy, Cable believes that certain market sectors are getting ahead of themselves.
“We believe many investors have ignored the potential tail risks that we are likely to face over the next few months as we continue to recover from the pandemic’s devastating impacts.”
Cable highlights the juxtaposition of rising global stock markets against the world’s on-the-ground reality of slower-than-expected vaccine rollouts and more virulent virus mutations that could affect vaccine efficacy, along with rising job losses and small business closures.
“The fear of missing out has prompted some investors to abandon any defensive stance in their portfolios, and they risk scoring a few own goals as a consequence.
“In our opinion, investors need to balance offence and defence when constructing portfolios in the current environment.”
Conversely, some investors may tilt too far towards a defensive strategy in response to the prevailing risk factors.
“Given the income desert, both locally and globally, hiding out in cash is no longer viable in the pursuit of inflation-beating returns.”
Asset allocations in a balanced strategic portfolio should include a concentrated selection of high-quality, underpriced global cyclical stocks with low leverage, low economic sensitivity and exposure to growth vectors unavailable in SA, says Cable.
“Local risk factors warrant a defensive position on SA Inc businesses. Our preference is the relative safety and real returns available from SA government bonds.
“We believe that SA inflation-linked bonds over short durations — less than 10 years — are particularly attractive given the muted inflation expectations priced into shorter-dated maturities relative to our base case inflation forecasts. These assets should form part of a diversified portfolio. For longer-dated maturities greater than 10 years, we prefer nominal bonds.”
Ultimately, Cable believes that investors require a balance between offence and defence to navigate the expected volatility in the year ahead. However, traditional safe havens may no longer offer investors the requisite safety and income they need in the prevailing environment. ●