Election passes with no cause for concern
1 .We are seeing some potentially explosive political developments – not only in South Africa but in the rest of the world. How do you think these will impact listed equity, bond and property market investment returns, and why?
Anet Ahern, CEO at PSG Asset Management: We are long-term, bottom-up investors. Consequently, we do not attempt to make macro forecasts (rather, we evaluate securities based on their individual merits) and apply our process with discipline to avoid being swayed by short-term noise. That said, environments characterised by fear and uncertainty tend to present the best long-term opportunities. As the prices of high-quality assets fall due to negative sentiment, they present the potential for outsized returns once the panic passes. We have been finding what we believe to be such opportunities across almost all asset classes, which is a rare position to be in. Vanessa Mabophe, Quantitative Analyst at Prescient Investment Management: Even if favourable results materialise from the elections on 8 May, South Africa’s rather bleak economic prospects would be left unchanged in the short-to medium-term. Though the earnings yield that the All Share Index trades at is currently in line with the MSCI Emerging Markets Index, it remains low when compared to the long-term average, which implies that the market is not cheap. However, we are positive on global economics, especially given high profit margins in the US, coupled with the slope of the US curve that is still in positive territory. Generally, these economic fundamentals should be supportive of risky asset classes like equities and credit.
Currently, local listed property offers great value as the dividend yields are in the top quartile relative to their respective historic dividend yields. However, the materialisation of the land expropriation bill could adversely impact returns on listed property. At Prescient Investment Management, we believe that current local economic fundamentals still favour riskier asset allocations. However, domestic and global political risks could erode these returns.
Razeen Dinath, Head of Equity, Cadiz Asset Management: A major concern when assessing an investment is whether your rights to the asset is secure. This is directly linked to security of property rights and the rule of law (independent judiciary). Any signs that these key factors are being significantly diminished by political developments would lead to lower confidence in the system and hence less demand for the investment and lower return.
The latest pronouncements on expropriation without compensation in South Africa lowers confidence, but the actions of President Cyril Ramaphosa to strengthen the independence of the prosecuting authority and the commissions of inquiry adds confidence that South Africa should enter a period where State capture and corruption is reduced. This will lead to improving business confidence and enable stronger economic performance to the benefit of all South Africans.
2 .Are you trying to be a bit more conservative and maybe moving money from equities into other asset classes (nominal and inflation-linked bonds, credit, local vs. international markets, etc.)? What is your current view on each asset class?
Anet Ahern, CEO at PSG Asset Management: We have been finding good long-term opportunities across almost all asset classes.
Local and foreign equity: Our multi-asset portfolios have a sizeable weighting to neglected SA Inc. stocks; an opportunity we’ve highlighted for some time. Stocks exposed to the local economy remain out of favour given the low-growth environment and intensified political tension. However, businesses with proven track records and strong management teams have a good chance of weathering the storm – as they’ve done before. Globally, valuations remain high, but we continue to find select opportunities in less popular market segments. These include investments in the UK, Japan and US real estate.
South African fixed income offers compelling value: In our view, long-term government bonds currently present one of the most attractive risk-adjusted opportunities in our portfolios. In fact, a recent study by Morgan Stanley shows that the real yields on SA government bonds are presently the highest among investment-grade peers. In addition, both longer- and shorter-dated inflation-linked bonds continue to offer notable real yields, along with an inherent buffer against upward inflationary shocks (although we deem this unlikely).
Good prospects in US real estate: Fears around the impact of Amazon and other online players on traditional retail outlets have presented an opportunity in US retail real estate. Some of the businesses in this sector have valuable property portfolios, which we think the market is underestimating. The shares also currently offer high real dividend yields.
Credit exposures are limited: We have reduced corporate bond exposures in our multi-asset funds, as several existing investments have reached our estimates of intrinsic value. Given that these are illiquid instruments, their hurdle for inclusion in the portfolios is high. As such, we are finding few new opportunities that compare favourably enough to those in other asset classes.
Vanessa Mabophe, Quantitative Analyst at Prescient Investment Management: At Prescient Investment Management, we expect the prevailing economic fundamentals to favour riskier asset allocations. Locally, inflation has fallen faster than short-term rates, resulting in the real yield of interest-bearing assets rising. This also led to rates at the longer end of the curve correcting more sharply as inflation expectations fell. In addition, on a relative basis, SA and emerging market real yields are more attractive than their developed market counterparts and therefore we are overweight SA and emerging market bonds, but underweight US and European bonds.
Overall, we are neutral on equities. Equity valuations are on the expensive side and business sentiment is negative in SA. However, this is balanced by positive global economics (which likely won’t roll over in 2019) and favourable global financial conditions.
3 .We’re seeing dividend yields on the Alsi of around 3.5%, and multiples at relatively low levels. What is your view of potential returns for 2019, and what are the drivers of those returns, to watch out for?
Anet Ahern, CEO at PSG Asset Management: We invest for the long term and don’t attempt to forecast short-term returns.
William Fraser, Portfolio Manager: Political developments are important if political change might result in While there is a range of outcomes from these levels, we believe the market is not that cheap once you factor in deteriorating aggregate demand and contracting corporate margins (inflation is anaemic and volume growth is negative on a like-forlike basis). Forward multiples should also be adjusted to assume a less positive outlook for commodity demand and thus earnings from mining companies.
We expect real JSE equity returns to be below historical norms on a three-year view, recovering when measuring the outlook over a five-year horizon (i.e. returns are likely to be back-end loaded on a five-year view). Trying to time the markets in the short-term is a dangerous game – in our experience it is preferable to take a long-term view and stay the course.
Vanessa Mabophe, Quantitative Analyst at Prescient Investment Management: We anticipate that equities will remain flat in the short- to medium-term. The P/E ratio has advanced to levels above its long-term average and, based on the ratio, the JSE all share index is currently overvalued.
Though the earnings yield that South Africa trades at is currently in line with the MSCI Emerging Market Index, it remains lower than the long-term average spread. Therefore, in comparison to the MSCI EM Index, the relative earnings yield for SA equities is, on aggregate, low, making SA less attractive than our emerging markets peers.
Overall, we are positive on global economics, especially given high profit margins in the US, coupled with the slope of the US yield curve that remains in positive territory. However, local politics (including the elections outcome, proposed nationalisation of the SA Reserve Bank and Eskom) could result in SA receiving less attention than our emerging market peers should global political risks subside and a risk-on environment lead to asset flows back into emerging markets as a whole.
Razeen Dinath, Head of Equity, Cadiz Asset Management: Earnings growth is expected to be 7% – 9%, added to the 3.5% dividend yield provides a base line return of 10% to 12% for SA equity. The unknown factor is whether the stock market will re-rate or de-rate and this creates stock market volatility. In general the SA market is around fair value on our metrics and hence we do not expect a major re-rating. That being said, the equity investments that we are selecting are priced to provide a higher expected return over the next 3 to 5 years.
Aeon Management: Responses are from our portfolio management team members.
Jay Vomacka CFA: Senior Portfolio Manager, Aeon Management: The local market is a tale of two markets. South African centric equities and global equities (rand hedges). The fact that there may be some value requires a deeper look where. SA centric shares are just that, more driven by local factors, and there has been much value here for some time implying many potential value traps in the grouping. Certain fund managers have been increasing their weight into South African centric shares for some time but at Aeon Investment Management we were, and still are, not convinced and have been staying out to our clients benefit, thus far. One must ask what the catalyst is for these shares to re-rate and one could say elections may provide an underpin, given they end up positive, but it would be preferable to see real catalysts besides e.g. ‘Ramaphoria’ to materialise sustainably. This may take longer than expected (especially given the power struggle within the ANC) and sitting on the side-lines is preferred. As global growth increases and stabilises, as has been the case, shares with exposure to this are preferred. This continues to be the case especially since China has been increasingly positive and stabilising its decreasing GDP growth rate. This will do well for the entire world as China consumes more. At Aeon Investment Management, we are generally bullish on the global outlook and hence the local market, but more so in the equities that can take advantage of this global stability. Given this, key drivers to watch out for are global in nature such as China credit growth, Chinese GDP growth, European normalisation, European GDP growth.