Protecting the purchasing power of savings while limiting risk

portfolio management decisions to Prudential’s investment team.

In managing the Fund, the team makes asset allocation decisions (how much to allocate to each asset class such as equity, listed property, conventional and inflation linked bonds, and cash and money market instruments) and security selection decisions (for example, how much of a particular share to own within the equity part of the Fund).

These decisions generate the outperformance of passive returns that would have resulted if Prudential’s allocations were held static.

Prudential increases allocations to asset classes and securities that they view as attractive or cheap and vice versa for expensive assets.

The Fund has generated a gross return of 15.3 percent a year since inception in July 2001 to end-August 2012.

Over the same period, inflation was 5.8 percent a year. “In rand terms, this means that if you invested R100 000 in the Fund when it was launched and you reinvested distributions, your money would be worth R487 956 at endAugust 2012 (after fees).”

“It is important to note that since the Fund started, it has been the beneficiary of exceptionally good asset returns over the period and it is unlikely that these elevated levels of returns will be repeated in the medium term,” cautions Moyle.

“While past performance is no guarantee of future performance, we do take comfort in the fact that the Fund is managed according to a proven and successful process.

“Our commitment to continue applying this process within the framework of our prudent value investment philosophy bodes well for investors in the Fund,” he adds.

Asset allocation is typically key to fund outperformance, and Quinton Ivan, Coronation’s head of equity research, explains that asset allocation is not a formulaic process but rather an iterative one.

“There’s no hard and fast rule. Asset allocation is no different to any other investment decision. It involves a sober assessment of the risk-adjusted return expectation for each asset class. This is driven by valuation and the underlying fundamentals of each asset class.”

Assets are selected based on their total contribution to the portfolio. For instance, fixed interest exposure is assessed in the context of the domestic interest rate sensitive equity exposure.

Ivan says Coronation is bearish on inflation domestically given the upward pressures from administered prices such as electricity, water and property rates & taxes as well as real wage increases.

Inflationary pressures, coupled with three-decade low interest rates mean that the next meaningful move in interest rates is up. This is negative for nominal bonds.

Currency is another risk, and Coronation’s view is that even at current levels the rand is overvalued taking into account the size and funding requirement of the current account deficit.

“Our preferred asset class is global equities: valuations are generally attractive at 10x earnings for blue chip stocks that have strong balance sheets and healthy dividend yields of 3-4 percent, which is much better than cash. We’re at our maximum permitted limit offshore.

“Our view is that local equities are fully valued or even overvalued in certain instances. However, there is still value to be had in global stocks listed locally, such as MTN, SABMiller and Naspers.

“Consumer-facing businesses are overvalued, having been bid up aggressively primarily by foreigners who now own approximately 40-50 percent of most retailers.

“The market has now attributed a high rating to a high earnings base. The margin of safety on these shares is too low,” says Ivan.

“We’ve been buyers of resources stocks, with a preference for Sasol and the diversified miners, especially Anglo American.

“The prices of some miners have been hit so hard and share prices are now discounting a lot of the risks.

“On Financials, we still like the large commercial banks though we have taken some profit since the start of the year.”

As to other asset classes, Ivan says that Coronation is bearish on global bonds, with yields too low to compensate for the risks.

“There is currently a disconnection between record levels of debt and record low interest rates. This will ultimately translate into future higher inflation which is negative for nominal bonds.

“We prefer corporate bonds, as in most cases the credit risk of these corporates is better than their respective governments. The overall yield is also supplemented by the spread over the government bond.

“The local property sector has enjoyed a once in a lifetime bull market on the back of falling interest rates and a re-rating of the sector relative to bonds. This is highly unlikely to repeat in the future.

“However, globally there are pockets of value in Europe, Asia and Australia with some property on yields of between 5 and 9 percent,” adds Ivan.