While no one can predict the outcome of what will transpire in the year to come, the best thing investors can do is to remain disciplined, focused on valuations and identify opportunities in unloved, well-priced asset classes. In this context, volatility in market prices should be welcomed.
It’s tough for South Africans to have an optimistic view of the economy, not to mention their local investments. Last year, weaker nominal growth led to disappointment in government revenue collections, while a sovereign downgrade by Moody’s is looking increasingly probable in 2020. Eskom continues to keep consumers and cash conservers in the dark.
Add the numerous global risks in trade wars, geopolitical threats and an overhang of debt, underestimating a sharper-than-expected slowdown could spell disaster in 2020.
So what are local investors to do, to weather this looming storm? Should investors be preparing for a light drizzle or a full-on hurricane?
Herman van Papendorp, head of investment research and asset allocation at Momentum Investments warns that financial market volatility is likely to rise in line with the ebb and flow of market sentiment across asset classes.
“Instead, we believe it is prudent to use exposure to defensive asset classes as part of a diversified portfolio mix, while also providing some protection for portfolios where appropriate,” he says, adding, “before offering an annual outlook for each of the major asset classes”.
As strange as it may seem at the outset, van Papendorp notes that local equities’ recent lack of returns may be a good indicator of better future returns.
“In the past, when five-year trailing returns from South African equities were as low as is currently the case, subsequent returns from this asset class turned out to be very strong regardless of the prevailing macro environment at the time.”
This, he says, is testament to the global nature of the local equity market. “While attractive valuations also provide some margin of safety for South African equities against a weak local growth environment, a major near-term risk for local equities is a hard landing for the global economy, as the South African equity market typically performs poorly around the onset of a US recession,” van Papendorp warns.
In a yield-deprived global environment, van Papendorp believes South African fixed-income investments continue to offer very attractive real risk-adjusted returns to more than adequately compensate investors for idiosyncratic local risks. “Decent-yielding fixed-income investments have become a scarce commodity globally, as there has been an ever-increasing proportion of corporate and government debt in the developed world trading at negative nominal yields and even larger negative real yields.
“Local fixed-income investments, therefore, appear attractive in comparison, with vanilla bonds offering real yields of 4% to 5%; inflation-linked bonds [ILBs] having yields of about 3.75%, and cash yields a real return of around 2.75%.”
For listed property shares, van Papendorp notes that the operating environment remains tough against the backdrop of a weak local economy. “This has culminated in rising vacancies, below-inflation rental increases and negative rental reversions in the sector.”
However, the low valuation level in the sector shows that weak demand and supply fundamentals are already well discounted, van Papendorp adds.
“As a result, at current attractive valuations, the risk-return profile for listed property is now asymmetric, with more upside than downside.”
While any of the above asset classes could indeed perform better than expected, Victoria Reuvers, director and senior portfolio manager at Morningstar Investment Management South Africa, warns that significant risk remains, which can lead to adverse outcomes this coming year.
Ultimately, she says, given the persisting high levels of market volatility, staying focused on the fundamentals should remain the number one priority for local investors.
“When investors are faced with negative or sensationalist news, it’s hard not to worry and/or not to react, but even though acting on these calls to action may give investors a sense of control in the short-term, it is the surest way to destroy wealth in the long-term.”
Reuvers advises investors to steer clear of profit chasing, even though it might mean missing out on the occasional quick win. “We prefer to stick to our knitting and stay true to our long-term view,” she says.
“There will always be someone, some fund, some share or some investment strategy that did a lot better than yours (whether it be through luck or skill), and you may regret missing out. Fear and panic can force investors into making mistakes with their money, with envy being even more destructive.”
“It would serve investors well to remember that concerns and uncertainties surrounding the future are most likely already priced into any associated assets,” she adds.
At the end of the day, however, individual portfolio construction should always be approached keeping an investor’s time horizon and risk tolerance in mind. “Morningstar’s portfolios have exposure to areas of the market where we have high conviction, but we also remain diversified. While diversification may feel silly in the short-term, the reality is that it does pay off in the long-term,” Reuvers concludes.
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