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Alwyn van der Merwe

Director of Investments

After the extreme volatility of the financial markets in the first quarter of this year, the second quarter was also nothing short of tumultuous. How are investors to navigate the severe market swings? What do erratic markets mean for asset allocation, and is it time to start talking about the elephant in the room – gold? Our Director of Investments, Alwyn van der Merwe, shares his views on the market movements of the second quarter, and how we at Sanlam Private Wealth are positioning our clients’ portfolios.

Listen to Alwyn's views here:

Here is a transcription of the video:

To say that the first six months of this year was a very volatile time in financial markets, locally and globally, would certainly be the understatement of the century. We started the year in global equity markets on the front foot, but when the novel coronavirus broke out, financial markets came under severe pressure. Local equities sold off aggressively, with our own equity market selling off about 36% from the highs it recorded late in February. Globally, equity prices lost about 34% in dollar terms of their values.

However, the markets recovered significantly since the lows that were recorded on 23 March this year. Global equity prices went up by about 42% from those lows. You would recall that at the time the markets sold off, we thought it was overdone. When we position portfolios, we position them for a through-the-cycle scenario. So the ‘overdone action’ by financial markets provided us with an opportunity to increase risk in our client portfolios. Not only locally, where we added about 5% in multi-asset portfolios to equities, but also internationally in the Global High Quality Fund, where we used the liquidity that built up in the fund over a period, to reduce that liquidity significantly when we bought equities at much lower prices.

Unlike other bear markets that we’ve studied over the past 100 years, we’ve seen a material recovery – global equity prices recovered about 40% off the lows. And the South African market is about 25% up from those lows. Which simply means that the equities that we bought in that weakness, those purchases look very good and clients had the benefit of the increased risk that we’ve built into the portfolios, both locally as well as internationally.

However, if you compare the current recovery in equity prices to previous bear markets, I think it is fair to say that this recovery is certainly different to the past. In the first place, it was much faster. In the second place, what you’d normally find in recoveries is that the value equities lead the recovery, with the household names that had the performance behind them at the time when you went into the bear market, lagging in this recovery. This time it was different, when the momentum stocks continued with very strong momentum, and we can now clearly say that those stocks are quite expensive.

So what do we do now? Given the very strong recovery, you can understand that the prospective returns for global equities in particular have been reduced significantly. So as a result of that, we would suggest that we take some money off the table, or some profits on those shares that performed very well. It might sound very opportunistic, but just to put this in perspective: you would normally expect equities to do about 5% above inflation per annum if you look at the longer-term experience. That gives you, with inflation at about 1% or 2%, a 7% per annum prospective return for equities. Global equities are at 42%, so this means that in the last three months, we had seven years of performance, arguably off a low base. Given this very strong recovery, we’ve sold equities at these arguably expensive prices to lock in some of the profits that we’ve built in by the increased risk.

I think it is also important that we look beyond local and global equities. Looking at other asset classes such as global bond yields: in the US, 10-year bond yields trade at about 0.7%, which means that if you hold those bonds for 10 years, your return will be 0.7% per annum over the next 10 years. I think most of you as clients would recognise that not many of you would be happy with that kind of return. So the only reason we would hold global bonds in the portfolio is that in times of crisis, these assets normally respond as a shock absorber. But in terms of prospective returns, the returns are very muted.

Looking at cash as an investment opportunity – of course, cash returns globally are almost zero. And in South Africa, as a result of the cut in interest rates that we’ve seen, you can only get about 4% pre-tax returns if you invest your money for the next 12 months in liquid fashion.

So I think it is true to say that if you look across the spectrum, the prospective returns we’re talking about look quite muted. And therefore I think we need to be very nimble to use shorter-term opportunities to the benefit of our clients.

To conclude, the elephant in the room that we seldom speak about, is gold as an investment. Normally in times of uncertainty, gold performs quite well. This time around, it was not different. If you look at the performance of the gold price since the beginning of the year in dollar terms, it’s up 17%. However, if you look at gold shares that get the geared performance from the higher gold price, those gold shares are up almost 90% since the beginning of the year. We did not invest in gold shares because we think the longer-term prospects for the gold companies where the gold price is trading now, is not that great.

However, you can make a point that you should have some gold in the portfolios when interest rates are low and when uncertainty is high. Given the performance that we’ve seen in the gold price, we think most of that is probably behind us. So while we regret not having gold or gold shares in the portfolio over the past six months, we think that there are other shares, particularly value shares, both locally and globally, that are likely to perform better than gold. And therefore, for the time being, we will stay put, except if the gold price comes off and presents us with a better opportunity to invest.

In short, uncertainty will prevail. We’re not exactly sure how the COVID-19 virus will play itself out internationally and in South Africa. We’ve seen a significant bounce in risky assets, and we’ve taken profits. We have now put a portfolio together that has less risk. Should assets come off, for whatever reason, we would use that opportunity to increase the risk in the portfolio again like we did at the time when assets sold off in the first quarter.

When formulating your investment strategy, we focus on your specific needs, life stage and risk appetite.

Greg Stothart has spent 13 years in Investment Management.

Greg Stothart

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