Performance Summary

After a dismal first three months of the year for local equity and property markets many investors de-risked and parked their monies in cash and bonds. Listed property had plummeted 19.67% and local listed equity lost 5.97%. The Rand appreciated by more than 4% against the USD and as a result all offshore asset classes produced negative returns. 

The problem with a cash strategy is that investors may miss out on the upside once the markets return back to its longer-term return path. 

For investors which moved to low risk assets such as local inflation linked bonds and nominal bonds they subsequently lost 4.99% and 3.78% over the following quarter to end June 2018. Foreign investors sold more than R30 billion of local bonds – one of the largest sell offs on record and such put downward pressure on these low risk fixed income asset classes. Listed property also continued its slide and lost another 2.19% in value. Local money market assets produced positive returns of 1.76% but note how local equities produced a strong recovery of 4.54%. 

Offshore bonds, a safe haven for conservative investors, also lost ground during the second quarter declining by 2.75% in Dollar terms whereas offshore listed property and listed equities produced 5.21% and 0.53%. In Rand terms offshore assets produced a strong result in local currency as the Rand depreciated materially against the greenback. Offshore bonds yielded 12.91%, offshore property 22.20% and offshore equities 16.76% in local currency terms. Whilst the Rand has been a poor performer over the quarter it has faired much better than the extreme depreciation, which the Argentinian Peso, the Turkish Lira and the Brazilian Real experienced. 

It has been another quarter, which simply emphasized the importance of diversification across asset classes and also across both low risk as well as growth assets. It was also a quarter during which investors were reminded that investing is not about timing the markets but time in the market. 

For the 12 months ending June 2018 local inflation linked bonds and nominal bonds yielded 1.51% and 10.19%. Local listed property shares had now lost 9.94% on average. The pull back in the listed property sector could now be seen as an opportunity to increase exposure to this asset class and we have done so for our clients. Whilst the asset class is still not yet cheap it does offer a lower entry point at this stage. 

In terms of the local stock market we know such has been one of the top three equity markets over the past century and we were again reminded of its strength during the past 12 months as it rose by 15.02%. A local cash investment would have only yielded 7.35% over this period. 

Looking abroad, all major offshore asset classes produced positive returns in Dollar terms over the quarter ending June 2018. Previously we witnessed how the S&P 500 (a measure for the largest 500 shares in the US) produced a positive return in every single month of 2017. Whilst offshore listed equity is flat for the year to date it has still been a strong performing asset class if measured over 12 months to end June 2018, yielding 10.73%. 

The tables below outline the performance of the major local asset classes. The table below depicts the performance of local asset classes in Rand terms. The results show that it certainly has not been the best of times when looking at the numbers over the past 4 years. 

The table below depicts the performance of the major offshore asset classes in USD terms. With rates moving up in the US it has now had an immediate negative impact on global bonds. Even the past 5 years shows that global bonds have not yielded returns in excess of US inflation. Offshore Dollar cash has consistently underperformed US inflation over all periods over the past 10 years. Offshore property and equities produced real returns over most periods and have been the preferred asset classes for most investors. 

The table below depicts the performance of offshore asset classes in Rand terms. It can be seen that the Rand has depreciated by 5.78% per annum versus the Dollar over the past 10 years. The results also shows that it is not always a one way bet against the Rand as it actually strengthened versus the Dollar if measured over the past 2 years. 

LOOKING AHEAD

As South Africans we should continue to be cautiously optimistic about the future. We’re a country with so much potential and so many possibilities – 2018 can still be our year. 

Yes, the latest fuel price hikes (petrol is up 24.6% over the past year) and the VAT increase makes us, as consumers feel grim. At least we could expect the Reserve Bank to keep interest rates on hold for the rest of the year. Hopefully structural reforms shift South Africa to a higher growth rate for the rest of the year. Also, at least we have more policy certainty under President Ramaphosa and the major risk of a credit downgrade to junk have faded. 

If we continue to invest smartly our clients investments will continue to grow. For example, at current levels our bond markets offer attractive real returns and well priced versus other classes. Further, since the recent sell off of local listed property shares have we increased our client allocations. It may continue to produce muddle through short term results on the back of disappointing local economic growth numbers and concerns about a medium term rising interest rate environment but for the longer term it should produce strong real returns. 

The JSE has experienced a really difficult period over the past 4 years – the market has been a minefield with so many shares halving in value (almost a fifth of the shares). Many investors would argue they have had it and would rather just invest their monies in cash. They must just remember that there has never been a 5-year period in South Africa where local equities have underperformed cash. Investors should also remember Warren Buffets’ most famous words “be fearful when others are greedy and be greedy when others are fearful.” 

THE OUTLOOK GOING FORWARD IS BRIGHTER THAN IT HAS BEEN IN A WHILE FOR LOCAL EQUITIES AS WE MAY JUST SEE A REBOUND IN ECONOMIC ACTIVITY IN THE SECOND HALF OF THE YEAR. SO, IT’S NOT ALL BAD NEWS – THERE ARE ALWAYS INVESTMENT OPPORTUNITIES. 

Looking abroad, the concern remains that US equity valuations remains extended. The business life cycle of the equity market may likely slow down in the next 12 to 18 months. Continued trade uncertainties between the US and China may continue to have a negative impact on the markets. As the saying goes “When elephants battle, the grass suffers.” 

We also have to keep a close watch on our clients’ emerging market exposures as such has come under pressure due to concerns about a potential global economic slowdown. Unexpected monetary tightening by major central banks and slowing economic growth could result in further weakness across emerging market assets. A continuous rising Dollar will further squeeze emerging markets with large external debts. The latest weakness in our own exports could also intensify if global trade protection increases and leads to a global slowdown in trade. What we at least do know is that most emerging markets are in better shape today than during past crises periods and therefore these markets should sustain the pressures better than in the past. 

In terms of currency exposures, while the Rand is now trading at much weaker levels, investors should not assume that the currency will continue to weaken but should be aware of the potential of Rand strength. At R13.73 to the Dollar it seems to be decent levels to yet again implement currency hedging strategies which protects investor’s offshore assets against Rand strength but which allows them to participate in adequate Rand weakness should the Rand slide further. 

In summary, looking forward the range of possibilities, macro uncertainty and possible return and risk scenarios has widened. Higher interest rates, a strong Dollar and less easy monetary policy may reduce liquidity into the markets. Also US – China economic tensions are heating up and such may be around for a prolonged period. 

INVESTMENT STRATEGY

We remain pro growth assets but are cognizant that the current ebb and flows of the markets will continue as macro risks rise. Whilst we expect steady global growth ahead and don’t see any major flashing red lights we know that we have to build in greater resilience into our clients portfolios. As a result we favor protection strategies across our clients growth assets as well as currency exposures. 

Also we favour short duration in fixed income assets. We also believe that thematic investing in companies that excel on environmental, social and governance (ESG) metrics may provide increased resilience to our clients listed equity portfolios. We have been a strong supporter of the ESG theme over the past 5 years and such has benefited our clients’ portfolios. 

On the back of higher short term yields offshore we are now looking to find flexible fixed income offshore portfolios which produces a decent cash plus type return and such producing a positive real yield. 

INVEST ALL ASSEST OFFSHORE?

Other investors are thinking that now that the Rand has strengthened so much against other major currencies now is the time to take as much assets offshore as possible. Many investors think offshore investments have a better chance of outperforming local markets, as the Rand should now most probably depreciate against major world currencies. These perceptions, can tempt investors to take more capital offshore than their risk profile justifies. But a mistake like this can have significant financial consequences.  

While the Rand is now trading at much stronger levels, investors should not assume such has had its run and will now most surely weaken again, but should remain aware of further potential Rand strength. With a risk on environment, a positive commodity cycle and the Ramaphosa effect, the Rand has potential to strengthen even further and if it does it could trade below R12 to the US dollar in the next 12 months. On the downside, the Rand could weaken to around R13.50.

Furthermore, developed offshore equity markets, especially the US is trading at expensive valuations (even post the recent pull back) and could see further profit taking. It is therefore important to size an investor’s offshore allocation appropriately to cater for such all scenarios. 

Investors should keep in mind that South African listed equity markets still deliver competitive returns. Our stock market has been one of the top three equity markets over the past century and we were again reminded of its strength during 2017 when it rose by 21%. Over the past 10 years our equity market performed in line with global developed equity markets in rand terms, returning 11% per year in Rand terms. 

For all these reasons, we believe it is prudent to not always blindly maximise one’s offshore allocation. It is important to size the allocation optimally according to your risk profile. 


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