Finding real returns in 2017
As 2017 gets underway, a look at asset valuations across the globe tells us that, going forward into the new year, returns that substantially beat inflation are likely to be harder to come by for South African investors than they have been in the past few years. Not only is global growth slow, but many assets are expensive compared to their long-term histories. This means that investment managers like Prudential will have to search even harder for attractive sources of real returns, while being ever-vigilant of the risk involved. Political risk will also play a greater role in the new year given the uncertainty surrounding the policies of the Trump administration in the US, Brexit in the UK and possible election victories for anti-euro populists in France, Germany and the Netherlands.
Finding good value in SA bonds
So how are we positioning our multi-asset funds to earn the best possible returns over the medium term? From a global perspective, we believe that South African bonds are cheap compared to their long-term fair value, and offer good prospective returns. This follows their weakness stemming from elevated political risk (incidents such as “Nenegate” and threats to the Finance Minister’s position), as well as the ongoing risk of a credit rating downgrade, both being priced into yields. Relatively high yields of around 8.9% (for the 10-year government bond at year-end 2016) offer attractive real returns on a risk/reward basis. The stronger rand, easing of inflation and diminished likelihood of further interest rate hikes have improved – to an extent – the outlook for interest-rate-sensitive assets like bonds and listed property, despite very slow economic growth.
Local listed property, meanwhile, is priced to deliver low-double-digit returns in the medium term (in the absence of a market de-rating). This is well above inflation, and we consider it attractively priced. As such, we are overweight both SA bonds and listed property (to a lesser extent) in the Prudential Balanced and Inflation Plus Funds.
SA equities now more attractively priced
South African equities fell to cheaper valuations in December compared to their long-term fair value: at 31 December 2016 the FTSE/JSE All Share Index’s 12-month forward P/E was 13.8x, versus 15.2x at the end of September. In response Prudential moved to an overweight position in our multi-asset unit trust funds. Within equities, we are underweight expensive global heavyweights like Aspen and Steinhoff. By contrast, British American Tobacco is one of our top overweights as a solid defensive stock. We also retain our defensive positioning in resources, being underweight specialised miners like Anglogold and Implats, and preferring diversified miners (like Anglo American) and non-mining shares such as Sappi. We are also overweight financial stocks, including Old Mutual, Barclays Group Africa and Investec, all of which remain undervalued. Finally, we continue to be underweight retail shares, despite the recent improvement in valuations, as we believe SA consumers and the economy will continue to struggle over the medium-term.
Global equities expensive, especially in the US
For global equities, our portfolios are currently neutrally weighted generally. This is despite a rally in share prices in November and December of this year (particularly in the US) as a result of the surprise election of Donald Trump, in anticipation of more expansionary spending policies. Some European markets do still offer value, where concerns over growth have kept share prices under pressure. At the same time, certain emerging market equities are also valued attractively, but we are very selective in our exposure as many also come with relatively high risks. India is a market that we like. In the Prudential Balanced Fund we are near the 25% maximum exposure allowed for offshore equity.
Prepare for volatility, take advantage of downturns
In conclusion, South African investors can expect continued volatility in 2017 amid high levels of global uncertainty and political risk. The bullish Trump-related rallies in the US could yet prove to be overdone. Locally, despite the marginally improving outlooks for inflation, interest rates and growth, material risks remain for a possible credit rating downgrade mid-year. Economic growth remains sluggish and pro-growth reforms difficult to implement. To cope with market volatility, investors would be prudent to save and invest more, stay well diversified, maintain a long-term view and ignore the short-term “noise”. Remember that there are always opportunities to add well-priced assets to a portfolio in downturns, and as an investment manager Prudential will certainly be taking advantage of these.
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