By: Herman van Papendorp & Sanisha Packirisamy of Momentum Investments,
Will SA equities bounce back, or is fixed income still the best bet?
As 2019 draws to a close, it’s tough for investors to have an optimistic view on the economy. Locally, weaker nominal growth has led to another year of disappointment in government revenue collections, while a sovereign downgrade by Moody’s is looking increasingly probable in 2020.
While incremental gains on structural reform efforts herald a tepid growth recovery in South Africa from less than 0.5% in 2019 to under 1% in 2020, 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.
“With numerous global risks prevailing (trade wars, geopolitical threats and an overhang of debt), underestimating a sharper-than-expected slowdown could spell disaster in 2020. 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, 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 that 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 around 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, Sanisha Packirisamy, Economist at Momentum Investments acknowledges the meaningful risk for a more adverse performance outcome in 2020. “Ultimately, given the persisting high levels of market volatility, staying the course remains the number one priority for South African investors.”
She believes that the best way to do this is to shift focus away from tracking arbitrary market benchmarks and towards goal-based investing and personal benchmarks. “Chasing performance can be a dangerous gamble, and volatile markets increase the risk of buying and selling at the wrong time.”
“By moving away from the industry herd, we believe that investors will be able to focus solely on their personal investment outcome and risk budget. This is essentially the underlying philosophy behind Momentum’s outcome-based investing (OBI) score and toolset, which enables our advisers to select and compare portfolios that will deliver on clients’ specific outcomes,” Packirisamy concludes.