The current investment environment is extremely tricky. High levels of volatility, the likelihood that the US Fed will start raising rates and economic stagnation in large parts of the world makes it very difficult for investors to know where to put their money.
It is also largely assumed that equity markets are no longer offering value. Having run hard for a number of years on the back of massive global liquidity, they are looking quite stretched.
The problem, however, is that if you are considering how best to invest your money, you have to also consider the alternatives. If you are not going to invest in equities, what are your options, and how do they compare in relative terms?
For many local asset managers, the preference is to move into cash. Some of the country’s top flexible and balanced fund managers have unusually high allocations to money market instruments in their funds.
This is understandable. There is no risk in cash and as returns are likely to be in line with or slightly above inflation, it at least offers wealth protection.
At the moment, some analysts and fund managers feel that that is about the best investors can hope for. The risks elsewhere are just too high.
For Herman van Papendorp, head of macro research and asset allocation at Momentum, however, investors needn’t be quite so cautious. He believes that, relatively speaking, equities still offer the best value in the coming year.
As a starting point to his argument, he says that the currency will most likely remain weak. He does not see the potential for the rand to make a comeback as it did in the early 2000s when it dropped to over R13 to the dollar and then returned almost as quickly to levels around R6 to the dollar.
“You have to be very bullish on commodities if you think the rand is going to come back from current levels,” he says. “In the 2000s the rand strengthened on the back of the greatest super cycle in commodities in living memory.”
The Fed hiking rates will also lead to further rand weakness. This, in his view, means that global assets will continue to offer returns in rand terms.
And when looking offshore he believes that equities still offer far more value relative to bonds or cash. Not only are global equities probably fairly priced at current levels on a number of measures, but the alternatives look far more expensive.
“Whatever period you use, we are at historical lows in interest rates,” Van Papendorp explains. “That is good for equities because the cost of capital for companies is low, but not so good for fixed income because rates can’t go any lower. So at best you will get the running yield from bonds, but more likely you will make capital losses as interest rates rise and bond prices fall.”
At the same time, dividend yields in the developed world are higher across the board than bond yields. This makes equities decidedly more attractive.
Offshore cash, he believes, is the most expensive asset class because interest rates are so low that your return is close to nothing. The only growth for local investors will come from further rand depreciation.
Locally, while equity valuations are looking expensive in historical terms, there are still positives. The first is that he believes that the market will continue to be supported by the quality premium that foreigners attach to it.
“Foreigners own 40% of our market,” he says. “They are willing to pay a premium for South African equities because they get good corporate governance and good management that creates more value for them relative to other emerging markets.”
He also argues that the accelerating US economy is good for local equities. US growth generally encourages global growth and the fortunes of many of the companies listed on the JSE are linked to the global growth cycle.
While equities remain our preferred local asset class, bonds are not as expensive here as offshore. The emerging market premium has expanded over the past few months, because of concerns over Chinese growth which has increased yields. However rising interest rates will impact on prices.
At current levels local bonds are offering around the same returns as cash. Until yields push out further, therefore, it’s difficult to make the argument for taking the extra risk. Finally, Van Papendorp believes that local listed property is the most expensive local asset class. It offers very little margin of safety.
“Relative to bond yields, listed property yields have never been this low,” he says. “It has had such a phenomenal run, but it’s unlikely to give you the same returns.”
Positioning your portfolio
Equities are the clearly the preferred asset class, with gold and listed property being least attractive. The returns from global bonds and global cash are likely to be very muted.
Article sourced from Moneyweb