Stay abreast of COVID-19 information and developments here
Provided by the South African National Department of Health
TIME TO REDUCE RISK?
Alwyn van der Merwe
Director of Investments
Jun 26, 2020
Read more below or listen to Alwyn's views here:
After first ignoring the news around the COVID-19 pandemic, financial markets plummeted as the crisis escalated globally. From their peak in mid-February, the S&P 500 and the Nasdaq declined by 30% and 34% respectively, and the MSCI World Index by around 30%.
The largely indiscriminate sell-off in both global and local financial assets suggests that fear and panic drove investor behaviour – it was, in our view, an overreaction reflecting desperate actions by market participants. We argued at the time that macro events, even ones as severe and scary as this one, don’t usually have a material long-term impact on the true value of high-quality companies, provided that economic activity returns to normalcy after a year or two. We saw the extreme price movements as an opportunity to take on more risk and selectively increase exposure to attractively priced local equities in our clients’ portfolios.
Investors have certainly been rewarded by the global market rally since the end of March – and we believe our decision to buy deeply discounted assets at the time was correct. It should be said, however, that this market recovery has been unlike anything we’ve ever seen in a bear market. The S&P 500 and the Nasdaq have recovered by 46% and 42% respectively.
To put this dramatic upswing into perspective: since 1900, equities have on average typically produced real returns of 5% per annum. If one assumes an inflation rate of 2%, it implies a nominal return of 7%. We’ve therefore witnessed over the past 2.5 months what we normally see happening in financial markets over a period of around six years!
An important driver of the surprising bounce in global equity markets has been the aggressive measures taken by monetary and other economic authorities to mitigate the effect of the virus – by providing economic stimulus to counter its dire impact on economic activity. The resulting flood of liquidity has created a natural demand for financial assets, pushing up equity prices in particular.
There’s no denying, however, that despite these measures, the world has entered a severe economic slump amid COVID-19, and the near-term prospects for the global economy are looking decidedly downbeat. Put differently, the economic outlook and business conditions are still clouded by material uncertainty. In addition, the two main tail risks that dictated market direction last year – the US-China trade conflicts and Brexit – haven’t gone away and are likely to return to centre stage over the next few months.
In South Africa, the risks are even more pronounced as our economy limped into the economic fallout and it may be some while yet before we can start to claw our way out of the current meltdown. Finance Minister Tito Mboweni said during his Supplementary Budget Speech this week the local economy is expected to contract by 7.2% in 2020 – the biggest contraction in 90 years. The economic outlook is further dampened by uncertainty over when activity will be able to resume fully post-lockdown, an unreliable energy supply, and fiscal drag should the path of proposed fiscal consolidation become reality.
What we’re seeing is a major ‘disconnect’ between surging global financial markets and share valuations on the one hand, and gloomy ‘real-world’ economic prospects and concomitant decreased company earnings on the other. It’s almost as if the markets are completely at odds with the extreme economic and business uncertainty – a state of affairs which, in our view, is ultimately unsustainable.
What’s also concerning is the rating of equity markets, traditionally expressed as their price-earnings (P/E) multiple. At the start of the year, the MSCI World Index was trading at a multiple of around 21 times. As share prices collapsed, this figure fell to a level of 14 times but now, 2.5 months later, it’s back even higher at 22 times. So if we were edging into dangerous territory in terms of valuations before the current crisis, the situation is even more troubling now.
It’s for these reasons that we at Sanlam Private Wealth have decided to reduce risk in our clients’ multi-asset portfolios and trim our holdings in global equities – keeping the resultant cash offshore to make the best use of opportunities when they arise. In our view, the prospective returns currently offered by global equities generally don’t provide enough upside to justify the risk associated with the asset class.
One would be naïve to think that the local equity market will appreciate significantly if global equity markets are under pressure. From a valuation perspective, however, South African equities are looking more attractive than their global counterparts. Excluding Naspers, the forward P/E multiple of the JSE All Share Index (ALSI) is only 10.8 times (with a historic dividend yield of around 5.4%).
So, although the economic outlook for South Africa is sombre, there is still value to be found in our markets. Despite operating in a decidedly tough macro environment, many SA Inc companies (those that generate most of their earnings within our borders) are still high-quality businesses with good long-term prospects, and we’ve therefore not trimmed any SA Inc shares in our portfolios.
Local bond yields blew out late in March in a knee-jerk response to the downgrade by Moody’s of South Africa’s sovereign credit rating to junk. We viewed this as market overreaction and considered it an opportunity to use some of the cash in our portfolios to increase the bond holdings in some of our multi-asset portfolios where we held an underweight position. Since then, bond yields have fallen or prices have strengthened.
Despite the local bond market continuing to offer attractive returns – the 10-year bond yield is currently at around 9.3% – we won’t be adding to this asset class. Our main concern is the untenable fiscal position of our government, which has deteriorated significantly over the past decade – this was highlighted again by Minister Mboweni in his speech this week. You can read commentary on this by Investment Economist Arthur Kamp here.
Global bonds are not in our view a viable long-term investment option at present. The 10-year US and German government bond yields are now at around 0.7% and -0.4% respectively. Bonds have, however, traditionally acted as shock absorbers in multi-asset class portfolios – they do provide protection against equity market sell-offs. Despite low prospective returns, we do therefore have some exposure to global bonds in our clients’ portfolios.
Based on historic dividend payments, valuations of local property shares look attractive. However, many listed entities have already passed their dividend payments – historic dividend yield is therefore not a good measure of the value of the sector. The local economic fallout and the dim outlook for consumer spending and stressed balanced sheets have dampened the prospects for the sector and we therefore think it’s too early to consider adding to this asset class.
While the sharp fall in equity markets with the advent of COVID-19 provided an opportunity to buy cheap assets to enhance the growth potential in our clients’ portfolios, the subsequent rapid and aggressive market rise is in our view out of kilter with the realities of rebuilding the global economy after the pandemic lockdowns are lifted. For now, we deem it prudent to reduce risk by selling off around 5% of our global equity exposure in our multi-asset portfolios. While we are long-term investors – not traders – the current valuations are simply too rich.
We’ll maintain the cash proceeds of reducing our holding in global equities in the asset class. The cash will be used to acquire cheaper equities offshore should an overvalued equity market lead to lower future prices.
Sanlam Private Wealth manages a comprehensive range of multi-asset (balanced) and equity portfolios across different risk categories.
Our team of world-class professionals can design a personalised offshore investment strategy to help diversify your portfolio.
Our customised Shariah portfolios combine our investment expertise with the wisdom of an independent Shariah board comprising senior Ulama.
We collaborate with third-party providers to offer collective investments, private equity, hedge funds and structured products.
FISCAL WOES PROMPT BOLD PLAN
Investment Economist at Sanlam Investments
MTN: A COMPELLING
Senior Investment Analyst
HOW MUCH RISK SHOULD YOU TAKE?
Director of Investments
WHAT CAN WE EXPECT?
Investment Economist at Sanlam Investments
THIS TOO SHALL PASS,
BUT WHAT THEN?
BAT: STILL SMOKING
AMID COVID-19 VOLATILITY
Senior Investment Analyst
A COVID-19 WORLD
Director of Investments
OIL MARKETS: THE GOOD,
THE BAD AND THE UGLY
Member of SPW Investment Team
South AfricaSouth Africa Home Sanlam Investments Sanlam Private Wealth Glacier by Sanlam Sanlam BlueStar
Rest of AfricaSanlam Namibia Sanlam Mozambique Sanlam Tanzania Sanlam Uganda Sanlam Swaziland Sanlam Kenya Sanlam Zambia Sanlam Private Wealth Mauritius
GlobalGlobal Investment Solutions
Sanlam Private Wealth (Pty) Ltd, registration number 2000/023234/07, is a licensed Financial Services Provider (FSP 37473), a registered Credit Provider (NCRCP1867) and a member of the Johannesburg Stock Exchange (‘SPW’).
All reasonable steps have been taken to ensure that the information on this website is accurate. The information does not constitute financial advice as contemplated in terms of FAIS. Professional financial advice should always be sought before making an investment decision.
Participation in Sanlam Private Wealth Portfolios is a medium to long-term investment. The value of portfolios is subject to fluctuation and past performance is not a guide to future performance. Calculations are based on a lump sum investment with gross income reinvested on the ex-dividend date. The net of fee calculation assumes a 1.15% annual management charge and total trading costs of 1% (both inclusive of VAT) on the actual portfolio turnover. Actual investment performance will differ based on the fees applicable, the actual investment date and the date of reinvestment of income. A schedule of fees and maximum commissions is available upon request.
COLLECTIVE INVESTMENT SCHEMES
The Sanlam Group is a full member of the Association for Savings and Investment SA. Collective investment schemes are generally medium to long-term investments. Past performance is not a guide to future performance, and the value of investments / units / unit trusts may go down as well as up. A schedule of fees and charges and maximum commissions is available on request from the manager, Sanlam Collective Investments (RF) Pty Ltd, a registered and approved manager in collective investment schemes in securities (‘Manager’).
Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. The manager does not provide any guarantee either with respect to the capital or the return of a portfolio. Collective investments are calculated on a net asset value basis, which is the total market value of all assets in a portfolio including any income accruals and less any deductible expenses such as audit fees, brokerage and service fees. Actual investment performance of a portfolio and an investor will differ depending on the initial fees applicable, the actual investment date, date of reinvestment of income and dividend withholding tax. Forward pricing is used.
The performance of portfolios depend on the underlying assets and variable market factors. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-dividend date. Portfolios may invest in other unit trusts which levy their own fees and may result is a higher fee structure for Sanlam Private Wealth’s portfolios.
All portfolio options presented are approved collective investment schemes in terms of Collective Investment Schemes Control Act, No. 45 of 2002. Funds may from time to time invest in foreign countries and may have risks regarding liquidity, the repatriation of funds, political and macroeconomic situations, foreign exchange, tax, settlement, and the availability of information. The manager may close any portfolio to new investors in order to ensure efficient management according to applicable mandates.
The management of portfolios may be outsourced to financial services providers authorised in terms of FAIS.
TREATING CUSTOMERS FAIRLY (TCF)
As a business, Sanlam Private Wealth is committed to the principles of TCF, practicing a specific business philosophy that is based on client-centricity and treating customers fairly. Clients can be confident that TCF is central to what Sanlam Private Wealth does and can be reassured that Sanlam Private Wealth has a holistic wealth management product offering that is tailored to clients’ needs, and service that is of a professional standard.