2022-05-Market Update and Outlook-Managers Q&A

IN THIS ARTICLE:

2022-05-Market Update and Outlook-Managers Q&A

If you are concerned about the volatility in your investments, we urge you to take five-ten minutes to read the first three pages of this report. We hope it will answer questions or address any concerns that you may have.

In order to address clients’ concerns we have asked six prominent asset managers four questions that are particularly relevant to client portfolios. I’ve summarised these questions below:

  1. What’s going on in the markets?
  2. What are you doing to manage risk in the portfolios?
  3. Is it still reasonable for investors with a balanced risk profile to expect an annualized return of inflation +5% in rand terms over the next 5 years?
  4. Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

For investors who are more inclined to ask, “what’s the bottom line?” we have summarised the manager’s responses to questions 2, 3, and 4 in table on the next page. For investors who would like to see the responses from the various managers, please refer to pages four through seventeen.

With regard to question 1, what’s going on in the markets, the answer is a lot! In the interest of summarising the fairly lengthy responses, our summary is as follows:

  • Global growth is slowing.The post covid recovery is arguably over.
  • Global inflation is a concern.Global inflation is the highest that it has been in recent history, particularly in developed markets. In South Africa, we are used to inflation being between 5% – 6%. Developed markets are used to inflation rates of around 2% and they are beginning to feel the pinch.
  • Interest rates are rising.If you have to pay more in interest repayments to service your debt, you are unlikely to spend as much money on credit. This deters spending and incentivises saving. This is the governments way of slowing down economic activity in an economy which is potentially overheating. Traditionally markets do poorly when interest rates are increasing.
  • US markets appear to be expensive.Would you knowingly overpay for a house? Based on the narrative that the US market appears to be expensive, its particularly vulnerable to “bad news” or lower corporate profitability than what people may have originally thought going into 2022. The US market is the largest market in the world and hence the concern.
  • Excessive consumer spending is moderating (falling).Governments stimulated their economies and, in some cases, paid the unemployed, “free money” to survive during the initial stages of the pandemic. As the “stimulus” has faded or reduced, people have less money to spend without taking on debt.
  • Russia Ukraine war and China’s zero covid policy.The Russian invasion of Ukraine has caused substantial damage to the global economy. We may yet to see the full extent of the damage and aftermath as a result of the war on food, energy, transport and manufacturing (supply chains) costs.

All these factors collate into an enormously complex and uncertain world. Hence the heightened levels of volatility in markets.

What are you doing to manage risk in the portfolios?

Is it still reasonable for investors with a balanced risk profile to expect an annualized return of inflation +5% in rand terms over the next 5 years?

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

Allan Gray / Orbis

Allan Gray and Orbis looks for undervalued companies. If the market doesn’t offer attractively undervalued companies, they may increase the “Fund’s weighting to alternative assets such as bonds, property, commodities, and cash, or we may partially hedge the Fund’s stock market exposure.” Although they didn’t directly answer the question, Allan Gray feels that they are holding very cheap assets with attractive upside potential. To illustrate their conviction, at the end of April 2022, their local balanced fund held an equity exposure of 71.5%. Historically their average equity weighting in the fund sits at 63%. This suggests significant optimism in the return expectation going forward. “Despite a strong year for equity markets and pleasing higher absolute returns, we are preparing for more uncertainty and volatility”

Coronation

“Security-level positions, asset allocation and hedging decisions are implemented in different portfolios in line with their respective risk budgets.” Simply put they are actively managing the portfolios from a risk perspective. It’s important to note that they are active and not necessarily reactive. “Unequivocally yes. If we deconstruct out multi asset funds (local and offshore), our current assessment of the upside to fair value in the various building blocks is significantly above average, which has historically been consistent with above average prospective returns. If clients can stay the course through the current uncertainty, their patience will be vindicated in due course” The short term is driven by sentiment and not fundamentals. With lots of uncertainty the sentiment is likely to be negative and hence volatility. “The rest of 2022 may still be tough but 2023 might well be better.”

Foord

Foord utilises hedges on the offshore side as well as having underweight positions in potentially expensive sectors which are priced for perfection. They also hold select companies with low levels of debt that are well positioned to grow their earnings and if necessary, weather difficult economic environments. “Yes. In particular given the derating that has taken place across asset classes in recent times. Valuations today are significantly more attractive, which is highly supportive of forward-looking real return expectations (over a long enough time horizon)” “The relatively high levels of uncertainty and rising geopolitical risks are likely to keep volatility levels higher than normal over the coming months. However, we would caution investors about the folly of market timing and would point to the Foord funds still substantial equity allocations, despite our macro-thematic caution.”

M&G Formally Prudential

Valuations are very different between global and local assets. Risk is managed through careful asset allocation based on starting valuations:” in other words if the risks are high, they will hold more defensive assets. M&G believe that there are attractively priced assets particularly in South Africa. They feel that they should be able to achieve a return of inflation + 4% based purely on how cheap the assets are. They feel they can also add another 1% in performance due to active management and selective stock picking. “Volatility will be the order of the day, given the current geopolitical climate, global inflation concerns and interest rate policies.”

Ninety One
Formally Investec

Ninety One’s “quality” team looks to buy quality companies which can grow their earning over time. Quality companies, coupled with managing asset allocation summarises the managers risk management processes. “Based on the expected five year returns, asset managers such as Ninety One should be able to deliver an annualised returns of inflation + 5% over the next 5 years for a balanced risk profile.” Ninety One’s Multi-Asset Quality Team. “Our central scenario for financial markets continues to be that volatility will likely remain high in the coming quarters.” Ninety One’s Global Multi-Asset Team.

36ONE

36ONE utilize a strong active management strategy. Where necessary they use active allocation to manage the risk within their multi-asset portfolios. “The funds expectations are based on a longer-term view of 3-5 years. Therefore, we do feel that this is a reasonable expectation for clients still. Notwithstanding the volatility intra those years.” “We expect the current volatility to continue with various factors at play, such as global inflation, China lockdowns and the Russia-Ukraine conflict. Our portfolios are well positioned to protect capital for our clients during this volatility. Additionally, volatility creates opportunity, and we are ready to take advantage of opportunities created by the volatile environment.”

A summary of the responses

What are the managers doing to manage risk in the portfolios?

Its important for investors to remember that the underlying fund managers are actively managing the asset allocation and stock selection within the portfolios. Some managers are utilising hedges or exposure to precious metals such as gold for uncorrelated defensive assets.

Fund managers are active but not necessarily reactive when markets are jumping around. Clients sometimes feel that they need to react when markets fall (as was the case during the covid crash) however, the reality is that doing nothing is in fact doing something, and that “something” is allowing the managers the time to navigate various markets environments as they are in the best position to do so.

Is it still reasonable for investors with a balanced risk profile to expect an annualised return of inflation +5% in rand terms over the next 5 years?

All of the managers with the exception of Allan Gray have overtly stated that they feel this return is reasonable and achievable over the next 5 years. All of the asset managers including Allan Gray are optimistic about asset prices outside of the US, particularly after the recent market fall.

On balance they feel that an annual return expectation of inflation +5% is achievable over the next five years in a balanced risk mandate.

Investors may find that the average return over the next five years may be very lumpy (periods of poor returns, followed by periods of high returns being delivered in a “lumpy sequence”). This speaks to the next question regarding volatility.

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

Yes. Each manager expressed their expectation that volatility is likely here to stay over the next 6 – 12 months as many market factors continue to play out. Investors need to be prepared for the volatility. We remind clients that volatility, whilst uncomfortable, gives managers opportunities to buy into attractively priced assets.

Simply put, clients should expect to see further fluctuations in the value of their investments. We remind clients that this does not reflect a poor investment decision but rather a short-term shift in sentiment. In other words, the market’s “feelings” (sentiment) is likely to shift from being positive to negative more than usual which results in volatility.

Allan Gray / Orbis Asset Management

What’s going on in the markets?

Developed markets have had an extremely lengthy period of low rates and abundant liquidity, which have created distortions in bond markets and supported equity valuations overall. In particular, investors have flocked to businesses that have demonstrated high levels of growth, causing the prices of those businesses to surge, which, in turn, has been exacerbated by tracker funds being forced to hold larger stakes in these companies to replicate the index.

The environment described have also contributed to a few broad trends which have dominated global markets in recent years. US stocks have beaten their ex-US counterparts, highly valued stocks have beaten cheaper ones, shares of big companies have beaten those of small companies, and businesses insulated from the economic cycle have crowded out their cyclical peers. As a result, markets have become ever more driven by an ever-narrower group of shares with ever-larger index weights and ever higher valuations to represent an ever-growing portion of world stock markets (most of these trends were headwinds for the out-of-favour shares that Orbis found most attractive, and the arrival of the pandemic only made it more intense).

More recently, with high commodity prices, inflation consistently above 5% in the US since June 2021 (7.9% as at the end of February 2022) and an overheating US economy, these trends have begun to reverse in 2022. Earlier this year, the Federal Reserve approved its first interest rate increase in more than three years and signalled its intention to keep hiking rates throughout 2022 and possibly into 2023. Year to date (as at 31 March 2022), the yield on 10-year government bonds in the US has increased from 1.5% to 2.3%, causing those same bonds to generate a negative return of 7.2% in US dollars. Higher interest rates have also meant higher discount rates, with a number of highly priced companies falling significantly.

At this stage, we do not know whether global inflation will prove to be transitory or more persistent in nature. We do know that developed market government debt is at record levels and that the real yield on long-dated government bonds continues to be negative in many countries. We also know that the average earnings multiple one is paying for US equities remains high relative to history. As a result, we are of the view that we are at the early stages of this trend reversal and continue to see substantial upside in our offshore investments relative to overall global asset prices.

Looking at domestically focused companies. Many of these companies’ business activities and share prices have continued on the post-COVID-19 recovery path from overly depressed levels. For example, local banks recently reported results that came in well above expectations. The promise of rising rates, in response to increased inflation, and the view that the worst impacts of the pandemic have now passed, serve as additional tailwinds. Select local shares, particularly those favoured by foreign investors, are also benefiting to some degree from the fallout from the Western sanctions placed on Russia. Historically, Russian stocks carried a material weight in emerging market indices, implying foreign investment flows are now likely to be directed towards more palatable markets, such as our own. In our view, this is supported by relative valuation levels, where the ALSI screens attractively versus both developed and emerging market peers

What steps are being taken in your global and local funds to manage risk within the portfolios

Both at Allan Gray and Orbis, we have always said that we do not have an edge in making macro predictions – and we maintain this – so we choose to stick to what we know and that is picking securities that trade for less than what they are worth. As investors, we should not pretend we operate in a vacuum that is nicely insulated from macroeconomic and political trends. However, it is equally important to distinguish between the economic environment and the prices you are paying for assets in that environment. While the underlying value of the assets we invest in can be impacted by tough economic conditions, if sentiment is low and those assets are already pricing in a poor economic outcome, they can still generate healthy investment returns.

In situations of extreme market volatility, our job as the investment manager is to remain disciplined and focused on the bottom-up analysis of individual securities and question whether their fundamentals have changed. We seek to buy shares at a discount to their intrinsic value.

We thoroughly research companies to assess their intrinsic value from a long -term perspective. This long-term perspective enables us to buy shares which are shunned by the stock market because of their unexciting or poor short-term prospects, but which are relatively attractively priced if one looks to the long term.

Using the Allan Gray Balanced Fund (the Fund) as an example, if the stock market offers few attractive shares, we may increase the Fund’s weighting to alternative assets such as bonds, property, commodities, and cash, or we may partially hedge the Fund’s stock market exposure. By varying the Fund’s exposure to these different asset classes over time, we seek to enhance the Fund’s long -term returns and to manage its risk. In addition, the Fund’s bond and money market investments are also actively managed.

Is it still reasonable for clients in your multi-asset balanced funds to expect an annualised return of inflation +5% in rand terms over the next 5 years?

We cannot comment on the expected return of multi-asset balanced funds over the next five years. In the case of the Allan Gray Balanced Fund (the Fund), we do aim to create long-term wealth for investors (within the constraints governing retirement funds) and to outperform the average return of similar funds without assuming any more risk. Taking a look at the Fund’s investment universe, our views are as follows.

Longer dated South African bonds are offering decent real returns, e.g. the benchmark rate for the 10-year government bond in South Africa is now in the ballpark of 10% (a real rate above 4%). In our view, while the risks in South Africa are well known, one is arguably being compensated for these higher risks at today’s prices. As it stands, the Fund’s holding of government bonds remains higher than usual, taking advantage of the steep yield curve. However, our approach to managing the fixed income portion of the Fund remains conservative, having a low duration of 5.2 years compared to the FTSE/JSE All Bond Index with duration at 6.6 years.

While the South African market may be trading near all-time highs when measured in rands, there remains substantial disparity in the returns experienced in certain sectors and within individual shares. Some sectors have been strong (such as mining), while others (such as hospitality, banks, and insurers) remain trapped by the consequences of the pandemic. We continue to see significant value in our preferred JSE-listed equities, and are able to find a number of domestically focused companies, that are either positioned to do well despite a poor macro backdrop, or pricing in a sufficiently dire outlook in today’s share price, so that even if the economy continues to be dire, the investment returns from that company can be very healthy.

In addition, we also see value in a number of global companies that happen to be listed in South Africa. These include companies such as British American Tobacco, Glencore, and Naspers. As at 30 April 2022, the net equity exposure in the Fund was 71,5% (we allow for a maximum allocation to equity of 75%). The current net equity allocation is far above our long-term average of 63% and this is a reflection of the fact that we have found a number of undervalued stocks which we believe are priced below their intrinsic value

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

Uncertainty is a fact of life, and ever present in investing. There are times, however, when uncertainty seems to dominate sentiment and news flow – and arguably we are in one of those periods. As a result, despite a strong year for equity markets and pleasing higher absolute returns, we are preparing for more uncertainty and volatility.

Whilst we cannot control the macro environment or the noise around it, the resulting pessimism can create opportunities for contrarians to invest in good companies at temporarily depressed prices. That is why we continue to spend the vast majority of our time focusing on what we can control: the price we pay for individual securities. Ultimately, our primary concern in making any investment is the risk of permanent capital loss.

As explained, we believe that the best protection against risk or permanent capital loss is to buy undervalued assets – assets bought at low valuations by long-term investors can withstand a litany of bad news and negative sentiment.

Coronation Asset Management

What’s going on in the markets?

While the IMF still forecasts global growth of 3.6% for both 2022 and 2023, the global economy is in a precarious position currently. Existing supply constraints and tight labour markets, exacerbated by continued lockdowns in China and a war, have combined with a period of ultra-loose monetary and fiscal policy to drive inflation in developed markets to levels not seen in decades. Central banks are responding by raising interest rates and tapering asset purchases, which are weighing on both consumer and investor sentiment.

The biggest risk that might well push, in particular the US, into recession is that central banks raise interest rates to the point where it materially impedes the ability of the economy to grow. Whilst no-one can be certain how this will play out, this remains a relatively low probability outcome in our view. Part of the reason why central bankers are more hawkish at the moment is to try and prevent inflation expectations from becoming unanchored, as last happened during the stagflation period in the 1970s. If this happens, the eventual pain will be larger as it will require higher interest rates for longer. Our current base case for US inflation is a gradual reduction to around 3% by the end of 2023, premised on a gradual resolution of supply-demand imbalances and a modest pickup in labour supply. There is upside risk to this forecast but if we are right, we don’t see a recessionary scenario playing out in the US. Financial markets already discount meaningful rate hikes to come, with an expected increase in the US Fed Funds Rate from the current 0.75%-1:00% to 3.25%-3.50%. The impact of interest rate hikes on asset prices are likely to moderate unless this expectation changes materially for the worse.

What steps are being taken in your global and local funds to manage risk within the portfolios?

The underpin in our portfolio construction process is conducting our own fundamental proprietary research, aimed at assessing the long-term valuation of assets (typically on a five to seven year view). We continuously revisit assumptions based on new information, but always with a view to understand the impact of current events and news flow on long-term asset value. Security-level positions, asset allocation and hedging decisions are implemented in different portfolios in line with their respective risk budgets. This approach has consistently added value over time, but does come with the cost of some discomfort resulting from occasional short-term performance disappointments. In the short run, the market is efficient to sentiment (i.e. momentum driven) which means that quality assets could temporarily trade significantly below intrinsic value. Over the long run, the market is efficient to valuation; market prices and fair values eventually converge.

While we are acutely aware of the macro risks, the reality is that many asset prices have already reacted to the difficult scenario painted above. The duration of the period of negative sentiment is uncertain, but after the sell-off we can confirm that we are finding lots of compelling valuation opportunities in both global and domestic equities currently.

In times of elevated inflation risk, we believe that it is imperative for long-term investors to retain healthy equity exposure, as this asset class has a much higher probability of protecting investor’s purchasing power over time than cash and bonds. Our aim is to invest in businesses that are competitively advantaged and attractively valued. These businesses include companies with a strong competitive position and pricing power, operating in growing markets, with capable management and a track record of accretive asset allocation. Examples include large internet platform businesses such as Alphabet, Amazon and Prosus; US railroads, cable providers and health insurers; strong, defensive consumer franchises such as Heineken; payment service providers such as Visa and lowest-cost operators in their respective sectors such as airline Ryanair. In our global multi-asset funds we also hold smaller allocations to other uncorrelated and real assets such as property and infrastructure (airports and toll roads), gold and merger arbitrage positions.

We acknowledge that we do not know when market sentiment will turn for the better, but perhaps counterintuitively it is often when most investors expect us to be sitting on the side lines that we have made some of the most accretive allocations to good ideas. From this perspective, a market decline is the patient long-term investor’s friend as it enables you to acquire high quality companies at undemanding prices.

Is it still reasonable for clients in your multi-asset balanced funds to expect an annualised return of inflation +5% in rand terms over the next 5 years?

Unequivocally yes. If we deconstruct out multi asset funds (local and offshore), our current assessment of the upside to fair value in the various building blocks is significantly above average, which has historically been consistent with above average prospective returns. If clients can stay the course through the current uncertainty, their patience will be vindicated in due course. This is how it tends to work overtime, our challenge (your and ours) is to convince investors of the eventual change in direction of travel and to still be there to benefit from it.

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

This is obviously a much more difficult question to answer than the 5 year question. Short term returns are random and most often have more to do with sentiment than fundamentals.

Commodities stand to do well, we own them, banks stand to benefit (a rising interest rate environment is often accretive for them, if they have manged their bad debts of course) we own them, local bonds stand to do well, we own them, the global diversifiers are natural insulators to SA and are in the main very cheap (think Naspers, British American Tobacco) we own them… and the list goes on.

Having said that its fair to say that in the short-term sentiment will prevail over fundamentals, I think the rest of 2022 may still be tough but 2023 might well be better. Market direction often changes when you least expect it; no-one rings a bell at the market bottom.

Last comment, and is one worth sharing with clients: Your clients don’t pay Coronation to avoid risk, they pay us to price risk. If we can do that well, that’s exactly where the outsized returns will come from.

Foord Asset Management

What’s going on in the markets?

The market ructions year to date are a combination of several intertwining factors:

  1. Liquidity withdrawal from central banks through higher interest rates and quantitative tightening;
  2. Higher government bond yields put pressure on equity Price/Earnings (P/E) ratios. As the yield on a “risk free” government bond increases, so the attractiveness of current equity earnings yields (E/P) decreases. This relative valuation dynamic causes earnings yields to rise (earnings yield is the inverse of the P/E ratio, so P/E ratios fall);
  3. Inflation pressures are leading to expectations that the FED and other central banks will move faster than previously expected, which wasn’t priced in previously;
  4. Inflation expectations are moving higher now through wage demands and commodity price increases, both of which are net negative for corporate earnings (by and large);
  5. The seemingly protracted Russian war in Ukraine has also unsettled markets, resulting in a move to dollar assets (commodities, dollar deposits), which has caused the US$ to rise quite sharply;
  6. Investors are exacerbating the negative cycle by selling equities and credit;

In summary, markets have moved from an “inflation shock” (through the end of 2021 as it became apparent that inflation pressures were less “transitory” than previously thought), to an “interest rate shock” (as it became apparent that the US Federal Reserve and other major central banks, will have to raise interest rates sooner and higher than previously expected; and finally to an “economic shock” which is the phase we seem to now be in, where markets have started to worry about rising risks of economic slowdown or even recession. A period of stagflation (stagnant economic growth together with high inflation) is an outcome that is rising in probability.

Our base case is that economic growth slows, but does not enter into a full blown recession and while inflation remains higher than it has been for the last decade, it settles back down to a level that is more tolerable for markets to live with, as the base effects of global supply chain stresses and spiking energy prices work there way through the system. However, the relatively high levels of uncertainty and rising geopolitical risks are likely to keep volatility levels higher than normal in the near term.

What steps are being taken in your global and local funds to manage risk within the portfolios?

For some years, Foord has been concerned about capital market distortions following a decade long “everything rally” and has been relatively cautiously positioned for some time. The funds have been underweight the relatively expensive US market (via hedges) and underweight the extremely overvalued US tech sector in particular. This has protected investor capital as intended. The funds have also had no exposure to government bonds or other yield sensitive assets given the expected negative consequences of rising interest rates on these asset types. However, with our base case expecting higher inflation than the market was pricing in, we have also not been able to take refuge in cash assets, given the extraordinarily low levels of interest rates and total lack of protection against inflation. As such, the preferred assets have been (and remain) specific equities in particular geographies, sectors and themes, that have pricing power over the investment horizon and robust (low debt) balance sheets to mitigate negative effects of rising interest rates on earnings and company valuations.

  • The mantra has been to maintain balance in portfolio, paying careful attention to not bet on any single outcome, given the uncertainties. In summary, positioning is as follows:
    • Equities with pricing power
    • Avoid long-duration DM bonds
    • Avoid property (yield assets)
    • SA Bonds with high real yields
    • Gold as a diversifier
    • Stay liquid

Is it still reasonable for clients in your multi-asset balanced funds to expect an annualised return of inflation +5% in rand terms over the next 5 years?

Yes. In particular given the derating that has taken place across asset classes in recent times. The more recent past has been a tough period for global balanced funds. But was a reflection on rating of markets, and a generally poor domestic equity market (save for resources). Valuations today are significantly more attractive, which is highly supportive of forward-looking real return expectations (over a long enough time horizon):

  • The local equity market is on a 10% forward earnings yield (real i.e. after inflation) while medium to long maturity government bonds are offering yields above 10%. Inflation is expected to average below 6% over the next 5 years, equating to a 4% real return at relatively low risk (and possibly higher should the yield curve move down as expected).
  • Global equities are now in aggregate on an earnings yield >6% (real i.e. after inflation). Even in the absence of rand depreciation, global equities are offering compelling value at current levels, on a three-to-five-year view. But we are cognisant that risks remain of a more pronounced setback in economic activity in the near term, and that margins and earnings are therefore at risk, which with higher bond yields may put further pressure on equity market P/E ratios.

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

The relatively high levels of uncertainty and rising geopolitical risks are likely to keep volatility levels higher than normal over the coming months. However, we would caution investors about the folly of market timing and would point to the Foord funds still substantial equity allocations, despite our macro-thematic caution. It is more important to be invested in the right securities and ride out the volatility, in confidence that the long-term growing income streams are likely to remain intact, than it is to try and time market movements.

M&G Asset Management

What’s going on in the markets?

We don’t profess to know where global inflation will be over the short term. Long term the notion of higher inflation is certainly something that will test investment managers’ processes. Central banks will react through the raising of real interest rates. SA’s relatively slow growth and the stronger rand meant that local inflation has been more subdued than that in many other countries. The last quarter marked the first time in many years that South African CPI was lower than that of the US. Even so, with CPI at the higher end of the SARB’s 3-6% target range and well above the 4.5% midpoint, the SARB hiked the repo rate by 25bps at both its March and January MPC meetings, as expected, to reach 4.25%, citing inflation and the war as the biggest threats. In March the Bank raised its expectations for economic growth to 2% for 2022 from 1.7% at the January meeting, but also lifted its 2022 inflation forecast to 5.8% from 4.9% previously. We expect this trend to continue. For a while now we have been highlighting the extended levels of valuations of markets such as the S&P 500. History has taught us that starting valuations is the precursor of what to expect in subsequent periods. Even after these falls, SA equity still trades at a price to book level of less than 2, still much lower than that of offshore equities.

What’s going on in the markets?

What steps are being taken in your global and local funds to manage risk within the portfolios?

In terms of managing risk, Regulation 28 allows for investment in a wide range of diversified asset classes, some of which we view as attractive. Valuations are very different between global and local assets. Risk is managed through careful asset allocation based on starting valuations:

We have maintained our portfolio positioning favouring local assets over global assets based on substantially lower P/B in the local market.

In terms of global assets, yields are still attractive in emerging market bonds. Investors are being compensated for the risk taken here, relative to developed market bonds.

Towards the end of last year the elevated levels of global markets have raised concern prompting our managers to increase foreign cash while decreasing offshore equity.

Our portfolios have recently benefited from our ongoing preference for SA nominal bonds thanks to their resilient performance. Valuations have been supported by these instruments’ exceptional cheapness relative to most other markets, SA’s improving fundamentals and the fact that SA inflation has remained relatively moderate.

In terms of property, we continue with our neutral positioning in SA listed property, preferring to hold other shares that we consider offer better value propositions for less risk. Conditions in the local property sector remain uncertain given the rising local interest rate cycle (many property companies are reliant on finance to expand their portfolios) and relatively weak growth prospects, among other fundamental factors.

Within equities, we hold stocks such as British American Tobacco which is a global defensive stock, providing downside protection better than we see on offer from gold.

As a result of rising market volatility we have also increased our SA cash holding by a small amount.

Is it still reasonable for clients in your multi-asset balanced funds to expect an annualised return of inflation +5% in rand terms over the next 5 years?

As per the below, there are a number of SA asset classes that are currently attractively priced, relative to their own fair value but also in terms of the CPI+5 objective that we have in for instance Inflation Plus. Based on the below, it is achievable to get to CPI+4 (at least) given a multi asset mandate, while aiming for an extra 100bp alpha inside each asset class through stock picking / instrument selection.

Local-prospective-real-returns-remain-attractive

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

Volatility will be the order of the day, given the current geopolitical climate, global inflation concerns and interest rate policies.

Ninety One Asset Management

What’s going on in the markets?

Ninety One Global Franchise Fund, Opportunity Fund and Cautious Managed Fund (Run by the Ninety One Quality Team)

Globally, we remain concerned about how the withdrawal of the record amounts of liquidity currently being provided by central banks and rising interest rates will affect global markets. We are already witnessing a sell-off in unprofitable technology companies, whose stratospheric valuations rely on long-dated (expected) profits being discounted at very low interest rates.

Despite these concerns, our preferred asset class remains global equity. as bottom-up stock pickers, we are highly selective in the individual assets we hold. Our preference is for high-quality companies that have enduring competitive advantages that form barriers to entry and provide pricing power. This in turn enables these companies to generate long-term growth and generate sustainably high levels of profitability. The global equities we hold, while trading on similar valuation metrics to the MSCI ACWI, collectively generate significantly higher returns on capital than the other companies in the market.

Locally, the best opportunity remains South African government bonds. South Africa’s real interest rates (the interest rates after subtracting inflation) remain among the highest in the world. With yields of around 9.60% (at the time of writing) on a 10-year note, these instruments offer higher risk-adjusted return potential than most domestic shares. While we have been increasing our allocation to select local equities, we remain cautious and believe the local equity market may not be adequately pricing in the risks that companies may face in the coming months.

Ninety One Global Strategic Managed Fund (Run by the Multi-Asset Offshore Team)

The invasion of Ukraine by Russia created stress across financial markets and has simultaneously placed upward pressure on inflation metrics, through supply chain disruptions and energy price increases, and downward pressure on growth. This has happened at a time when inflation globally is generally high and major central banks are beginning to withdraw policy accommodation. Central banks, and the Federal Reserve in particular, have sighted that lowering the rate of inflation is their primary objective at present. This presents a headwind to financial markets and investors should question the level of valuations against a backdrop of much tighter liquidity conditions and a moderating growth impulse. We see financial markets remaining volatile in the coming quarters as a result.

What steps are being taken in your global and local funds to manage risk within the portfolios?

Ninety One Global Franchise Fund, Opportunity Fund and Cautious Managed Fund (Run by the Ninety One Quality Team)

We are not short-term traders. Instead, we prefer to buy what we perceive to be high-quality companies that offer good value, and we hold these positions over the medium-to-long term.

The manager is actively assessing their holding and where necessary, they are either adding to or exiting positions based on prices and the underlying fundamentals. Their high-quality style lends itself to a buy and hold strategy rather than frequent trading.

The correct forecasting of complex global macroeconomic outcomes is almost impossible (as recent events bear testament to). Even if it were, positioning an investment portfolio precisely for such an outcome is even more challenging. We therefore do not believe it appropriate to position the portfolio for any event. Rather, we maintain a

The commentary below relates to the Ninety One Global Franchise Fund and offshore exposure within the local multi-asset funds that is managed by the Ninety One Quality.

Looking beyond short-term sentiment, we do not believe the current environment has significantly changed the fundamentals of the companies we own, which continue to compound cashflows at attractive rates. We remain comfortable that the quality attributes we seek (enduring competitive advantages, dominant market positions, strong balance sheets, lower cyclicality, low capital intensity, sustainable cash generation and disciplined capital allocation) are all well suited to both current conditions and for uncertain times ahead.

The commentary speaks to the resilience of the companies that they invest in and look to hold over the long term. The manager isn’t overly concerned with the fluctuations in the values of the underlying companies provided the fundamentals have not changed and that these businesses can continue to successfully grow their earning.

Ninety One Global Strategic Managed Fund

The Ninety One Global Strategic Managed Fund team have been utilising short positions by way of shorting equity futures as well as having short positions on select currencies. Simply put they are somewhat hedging their bets should the market continue to fall.

The Fund remains cautiously positioned, with an elevated exposure to Asian risk assets, as a function of these dynamics. We continue to watch the evolution of Chinese policy, the direction of developed market central bank policy, and the evolution of growth and inflation, believing that these are the primary forces driving financial markets from here.

Is it still reasonable for clients in your multi-asset balanced funds to expect an annualised return of inflation +5% in rand terms over the next 5 years?

The chart below shows the expected rand returns from the various asset classes. Simply put, with the exception of global bonds and USD cash, the other asset classes are expected to yield attractive real returns. Based on the expected five year returns, asset managers such as Ninety One should be able to deliver an annualised returns of inflation + 5% over the next 5 years for a balanced risk profile.

Range of expected five year returns for the portfolio

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

Ninety One Global Franchise Fund, Opportunity Fund and Cautious Managed Fund (Run by the Ninety One Quality Team)

Based on the “Quality Team’s” commentary, they are fully cognisant of the risks both locally and offshore. They have expressed concern over the markets overpricing of particular assets given the changing market backdrop. This coupled with their cautious approach suggests that there is an expectation of volatility over the next 6 – 12 months.

Ninety One Global Strategic Managed Fund

Central banks, and the Federal Reserve in particular, have sighted that lowering the rate of inflation is their primary objective at present. This presents a headwind to financial markets and investors should question the level of valuations against a backdrop of much tighter liquidity conditions and a moderating growth impulse. We see financial markets remaining volatile in the coming quarters as a result.

Our central scenario for financial markets continues to be that volatility will likely remain high in the coming quarters. As we look six to twelve months out, we believe investors should continue to focus on the change in liquidity dynamics in the developed world, while valuations in the US remain extended and growth may moderate as a function of sharply higher energy prices.

36ONE Asset Management

What’s going on in the markets?

Excessive stimulus during Covid has now resulted in a hangover for economies globally. Additionally, persistent high inflation in the US and other developed markets, means that the Fed and other central banks are unable to add liquidity/cut interest rates. This withdrawal of liquidity will put pressure on asset prices for the remainder of the year. Should the Fed decide to end its rate hiking cycle, we would become bullish once again

What steps are being taken in your global and local funds to manage risk within the portfolios?

Risk Management is a vital part of 36ONE’s investment process and is implemented at all stages and within all our long only and hedge fund portfolios. In extreme volatile markets as we are experience now, the funds were and are well positioned. We are closely monitoring the impacts on companies within our funds and as the situation changes, we will be sure to use our nimble size to adjust positioning where necessary. In some portfolios we will make use of additional cash to provide some capital protection.

Is it still reasonable for clients in your multi-asset balanced funds to expect an annualised return of inflation +5% in rand terms over the next 5 years?

The funds expectations are based on a longer-term view of 3-5 years. Therefore, we do feel that this is a reasonable expectation for clients still. Notwithstanding the volatility intra those years.

Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?

We expect the current volatility to continue with various factors at play, such as global inflation, China lockdowns and the Russia-Ukraine conflict. Our portfolios are well positioned to protect capital for our clients during this volatility. Additionally, volatility creates opportunity, and we are ready to take advantage of opportunities created by the volatile environment.