On Friday 24 February, the Financial Action Task Force (FATF) announced its decision to greylist South Africa. The decision has had both a reputational as well as economic impact on the country. With this said, the true impact of the news will only be revealed with time.

Background

In October 20211, the Financial Action Task Force (FATF), a global money laundering and terrorist financing watchdog, identified key weaknesses in some of South Africa’s financial regulations. South Africa was subsequently allowed to address these weaknesses and report back to the FATF as to how these weaknesses would be addressed (within roughly 12 months).

Of the 40 areas covered in the report, South Africa was found to be fully compliant in only three areas, largely compliant in 17 areas, and partially compliant in 15 areas. The five areas in which South Africa was deemed to be non-compliant include –

1. Targeted financial sanctions related to terrorism & terrorist financing
2. Non-profit organisations
3. Politically exposed persons
4. New technologies; and
5. Reliance on third parties

The main issues identified include concerns around money laundering, terrorist financing, generally high levels of crime and corruption, as well as the high levels of cash used in our economy (combined with a large informal economy which includes cross-border remittances).

The term “greylisting” is actually an external term and not necessarily a term used internally by the FATF itself. Officially it’s referred to as “jurisdictions under increased monitoring”. Countries on this list are under increased monitoring and actively work with the FATF to address strategic deficiencies to counter money laundering, terrorist financing and proliferation financing.

Currently, this list includes countries such as Albania, Barbados, Burkino Faso, Cambodia, Cayman Islands, Democratic Republic of the Congo, Haiti, Jamaica, Jordan, Mali, Morocco, Mozambique, Myanmar, Panama, Philippines, Senegal, South Sudan, Tanzania, Türkiye, UAE and Uganda. The most recent countries to have been removed from the grey-list were Nicaragua and Pakistan.

This is not exactly a list of countries a well-functioning economy would aspire to be part of. ‘You are the company you keep’ and ‘guilty by association’ – as the old sayings warn, right? What is also striking is the large number of countries from Sub-Saharan Africa.

There is also a blacklist, which contains only two countries, namely Iran and North Korea. These countries are deemed to be high-risk jurisdictions, that are not actively engaging with the FATF to address these deficiencies. The key difference between the two lists is effectively the willingness to participate actively in addressing the vulnerabilities identified.

So, what has South Africa done so far?

In a recent presentation to Parliament’s justice committee, national director of public prosecutions, Shamila Batohi, indicated that despite progress being made to address money laundering and terrorism shortcomings, the country was still behind in terms of meeting all the requirements of the FATF.

Parliament passed two acts last year to meet international anti-corruption standards. South Africa’s presentation at the recently held FATF meeting in January in Morocco (a country that was also recently added to the grey-list) was reportedly well received. It seems that 15 out of the 20 legal deficiencies cited by the FATF were adequately addressed. While there are still outstanding concerns, South Africa has certainly made a concerted effort to address some of them and is clearly paying attention and collaborating with the FATF. This should be applauded albeit not enough in the end.

To illustrate using a comparison, when Botswana was originally greylisted in October 2018 its 2017 country report by the FATF found:

– 23 areas (out of 40) of non-compliance

– 14 areas of partial compliance

– 2 areas of being largely compliant

– 0 areas of compliance

Recap of South African figures:

– 5 areas (out of 40) of non-compliance

– 15 areas of partial compliance

– 17 areas of being largely compliant

– 3 areas fully compliant

Botswana was removed from the grey-list only three years later in October 2021. The starting point was very different, with South Africa being in a much better position. Perhaps the country has done enough to avoid being greylisted completely, or if greylisting happens, the time spent on the list could be relatively short.

Impact of being greylisted

Financial institutions such as banks and administration companies have expressed their concerns regarding the impact of being greylisted. This is due to increased turnaround times (for transactions with international counterparts) and/or additional costs (due to enhanced due diligence procedures).

While the FATF standards do not formally require de-risking (avoiding entire classes of customers) or enhanced due diligence, financial institutions are expected to follow a risk-based approach and conduct detailed due diligence on customers from high-risk countries. It wouldn’t be unreasonable to assume that certain institutions would simply choose to avoid doing business with certain clients as opposed to triggering additional due diligence procedures.

We have often seen disparities between capital markets and how economies fare over the short term. To understand what could happen, one should look at these separately. Previous research has indicated little empirical evidence for banks to de-risk and avoid relationships with clients in “higher risk” countries or that investors globally use the FATF grey-list as a convenient heuristic to assess risk when making capital allocation decisions.

A recent paper by the International Monetary Fund (IMF), which uses a larger and more recent data set, does find significant negative effects on capital inflows highlighting a decline of 7.6% of GDP (on average). The paper also breaks down the impact on capital flows into underlying components, for example:

– foreign direct investments, down on average by 3%

– portfolio flows, down on average by 2.9%; and

– other investment inflows, down on average by 3.6%.

– All the impacts were statistically significant

– 1% alpha level.

Being greylisted would clearly be negative for South Africa and our President’s well-documented drive to attract foreign direct investment. The study, unfortunately, doesn’t allow for other conditions that might also influence capital flows such as increased bouts of loadshedding etc.

There are already a significant number of idiosyncratic risks prevalent in South Africa. One almost wonders if one more issue (added to the already long list of issues) would have an impact. Yet, the other side of the equation is that this could be the final straw to break the camel’s back and cause foreign investors to capitulate and abandon SA assets entirely. This seems unlikely.

Should South Africa experience additional reductions in capital flows, especially if it persists over the long term, the economy would suffer in the form of reduced economic growth, increased potential unemployment (and by extension inequality) and higher inflation (due to a depreciating currency). On the capital markets front, the cost of capital could potentially increase and domestic financial assets could become less attractive to foreign investors.

Markets are, however, forward-looking so most of the potential effects of greylisting should already be priced in. According to the Reserve Bank’s statistics, foreigners weren’t exactly rushing to buy either S.A. bonds or equities, but quite the opposite – they have been persistent net sellers over the last four years.

The risk is of course that international investors who still have significant amounts invested in South Africa could be triggered by the news to sell domestic assets. This forced selling might be an opportunity for local investorsto benefit from short-term volatility by acquiring cheaper assets without necessarily increasing the probability of suffering permanent losses on capital. This is also confirmed by both authors of the IMF paper as well as Becker and Noon (2008) that found that while FDI and portfolio flows experience similar declines, portfolio flows are more sensitive and tend to reverse after the initial shock.

Other examples

The sample of countries having been greylisted is small, but there are two recent examples on the continent – Botswana (greylisted in October 2018 and subsequently removed in October 2021) and Morocco (greylisted in February 2021). The below graphs indicate the reaction of their respective domestic stock markets to being greylisted:

In the case of Botswana, one could be tempted to conclude that equities indeed respond to a greylisting, however, as can be seen from the Moroccan example not so much. Besides that, one would have to isolate the effect of greylisting from other risk-off events. For example, the drawdown exhibited 11 months before Morocco was greylisted was due to Covid. Once again this is too small a sample to draw any meaningful conclusions from.

What about the European Union (EU)?

The EU adopted a new methodology in 2020 that relies significantly on FATF’s greylisting, however, unlike the FATF the EU doesn’t consider any ‘grey areas’. Countries either do not pose a risk to EU member countries or do, in which case they are added to a blacklist. No consideration is given to those countries that work with the FATF to improve areas of concern as identified.

EU requirements are therefore more onerous and expect member countries to apply a range of countermeasures (from enhanced due diligence measures, which leads to increased timelines and additional costs) to prohibiting EU financial institutions from establishing branches in the specific country. This in turn could lead to decreased foreign direct investments as already mentioned.

The EU methodology also states that it may double-check the work of the FATF or conduct its own assessments when countries are added to or removed from the FATF’s grey-list. There is therefore a potential risk that it might take longer to regain credibility with some of our largest EU trading partners.

Summary

Whilst it is still early it is difficult to make a convincing argument, based on currently available information, that domestic assets will suffer severe drawdowns. Over the shorter term, volatility could be expected, but over the medium term, prices would reflect a myriad of other drivers of returns.

What is perhaps a bit more obvious is the risk that greylisting poses to foreign direct investments, specifically from European countries. It is therefore imperative that South Africa address these weaknesses or shortcomings as identified as soon as possible. The longer the greylisting continues the worse these effects could be which would then inevitably feed through to asset class returns.

South Africa is, however, in a relatively good position, when compared to some of the incumbents on the grey-list and has already shown intent by addressing some of the concerns and weaknesses. The two laws already passed (in record time) should put us on an even stronger footing going forward and re-establish South Africa as an important global participant in the world financial markets.

As always, predicting the future is a mug’s game and with all the other uncertainties and risks currently prevalent in markets, the best approach is to always have a well-diversified portfolio, not dependent on any specific outcome. In addition, working with a trusted intermediary and having a long-term plan in place and sticking to it is possibly the best action one can take.

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

We will sweat the big stuff, so you can focus on what matters… read more

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Welcome to 2023. We wish you a prosperous year filled with health, happiness and success.

To support you, I’d like to share some financial tips for your interest, which may help you given the current state of the economy and markets. If any of the following interests you and you’d like to explore our professional opinion, please reach out as we’d be delighted to help.

• Review Your Goals for the New Year

It is a healthy exercise to review your goals at regular intervals, but this is especially important today. A research study by Morningstar called “Mining for Goals” shows that as much as 71% of people change their top 3 goals by doing a simple review exercise, which is quite remarkable and appears especially likely as we come out of the pandemic.

• Focus on Purchasing-Power After Inflation

Inflation has become a major issue for many households. By focusing on your purchasing power, you are successfully thinking in what we call “real terms” (which adjusts for inflation pressures). Reviewing your budgets and retirement funding needs are two worthwhile pursuits, but it is also worthy of reviewing portfolio progress to ensure it has a fighting chance of beating inflation.    

• Ask Yourself… “Am I Nervous or Fearful?”

Every investor will endure downturns on their journey, yet it is the ability to reflect and learn from the lessons that make for sound investing. During challenging times, it is worth marking down the lessons, including the fears or questions that drove your thinking. Behavioral coaching can add meaningful value – acting as a steady hand when you need it.

• Review Tax Arrangements

All too often, investors think in pre-tax terms. Whether we look at our earnings or our investment returns, many of us fail to consider tax implications. It is always a good idea to think about your tax structures to help increase after-tax returns.

• Portfolios Matched to Goals

Meeting goals is an individual experience and tracking the JSE FTSE ALL SHARE INDEX is not for everyone. By thinking through your goals and financial position individually, without comparison, you often get the best picture of financial health. Portfolio combinations that are matched to your goals and life milestones can be effective, but some people struggle with the complexity. We can help with any portfolio matching needs or queries.    

• Assess the Best Options for New Money

We always want to keep your financial aspirations and risk tolerance in mind, with different investment options available. Whether you want to “sleep at night” or “capture the discount”, we might be able to guide you through some of your best options.

• Just Rand-Cost Average

Sometimes, we can be guilty of analysis paralysis, or simple overthinking. By taking action in a building-block type approach, we can gradually break down our mental barriers and potentially increase the probability of success in reaching our goals. Rand-cost averaging means topping up your existing holdings on a gradual basis, which is often statistically better than doing nothing.

• Rebalance with a Total Viewpoint

As markets move, we should adjust. Rebalancing is not fool proof, but it can help manage risks, avoiding unwanted market drift. It is mostly used at the portfolio level, but you can do the same at a personal level – looking at everything from property to cash, and the ratios of each that you hold.

Summary

The above ideas are intended to nudge good investment behaviour and make sure you’re considering a broad perspective on your financial journey. We hope you found them insightful. To reiterate, if you’d like our professional assistance in implementing, we’d be delighted to help.

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

The impact of saving consistently through the up, down, and boring times

A sad, but harsh reality is that only 6% of South Africans can retire comfortably. “Comfortably” means that an investor retires earning 75% of their final salary in retirement, from the investments and savings put in place before their retirement. More often than not, investors only contribute the minimum percentage of their income to their retirement funding, wrongfully believing that this will provide them with an adequate amount with which to sustain their income during their retirement years. The following article considers not only the importance of saving but why doing so from an early age is so imperative.

Let’s start with the basics and why the principle of saving is so important

Savings is a simple concept – whether you are saving coins in a piggy bank, or percentages in your bank and/or investment account, it’s the principle of sticking to the habit of saving that is important. Warren Buffett’s wise words perfectly encapsulate how we should approach saving – “Do not save what is left after spending but spend what is left after saving”. It’s easy to spend money but it often leads to us not having much left to save, whereas, if you save first, you’ll spend what you have left a lot more mindfully (and cautiously).

It is important to note that, it’s the habit of saving that matters most, and less so the actual amount. Of course, the more you save the better, but getting into the habit can be the hardest part. You will be surprised how rewarding it is to see how quickly you can build up a nest egg and the incredible power of compounding.

Saving versus investing

We all want the best performing portfolio, but the reality is that performance is only one of the components on the journey to wealth creation. While you can’t control how markets will perform and/or your investments, you can control the amount you save every month.

The table below shows you the end value of investing a certain percentage of your disposable income every year for 30 years.

• On the left-hand side, we show you the rate of return assumption, and at the top is the percentage you have saved of your disposable income.
• We use the assumption that the investor’s disposable income is R500 000, that it remains unchanged for 30 years and we have made no tax assumptions, to keep things simple.

What does this teach us?

• If you generate a 10% per annum return for 30 years, but you only save 1% of your disposable income (in other words, R5000) you end up with R822 000 – displayed in the red block.
• On the other hand, looking at the top right section – if you generate an investment return of only 1% but saved 10% of your disposable income you end up with R1.7 million (as displayed in the green block).

This shows how extremely important the habit of saving is; and that you can end up with a 111% higher ending balance if you save 10% compared to saving only 1% – even though the annualised investment returns were 9% lower!

Start your savings journey as early as possible

Investors often assume that if they are starting small, they don’t have enough assets to invest. But the fact is, even if you have a very small sum that you can save and invest in the market, thanks to compounding, over a long-time horizon you may be able to accumulate more than the person who starts with a larger sum but waits for longer before investing.

The following example could be helpful if you are unsure how much you need to save given your current age. This does not consider the investment strategy you are in, but purely the amount that needs to be saved from your monthly income to retire comfortably at age 65. More importantly, what we illustrate here is the importance of starting your savings early.

The following assumptions have been made:

• A starting salary of R200 000 per annum (increasing by 4.5% annually)
• A growth rate on the investment of 8% and inflation of 4.5%.
• The investor’s final annual salary amounts to R1 163 272.91, meaning this investor would require an income of R872 454.68 in the first year of retirement to retire “comfortably” (which would reflect a 75% replacement ratio).

As you can see in the below graph, the later you start to invest the more you need to save per month, for example – if this investor started saving at age 25 he/she would need to save 15% per month to retire comfortably whereas if he/she started at age 50 he/she would need to save 62% per month to retire comfortably (at a 75% replacement ratio).

The late-start investor may be scrambling just to make a retirement plan work. People who get started earlier have a better shot at achieving shorter and intermediate-term goals along the way. The unfortunate reality is that very few people start saving early and save the correct (or rather an adequate) amount.

In closing

When thinking about your investment strategy, you want to think about the components you have control over. These components are your behaviour while being invested and the amount you save every month.

Some key points to remember:

1. Start saving from an early age and take advantage of the power of compounding
2. Markets do recover after market crashes and you can experience your best returns after a crash, so do not be fearful or scared while having a long-term investment strategy. Going through short-term market movements is part of your journey to wealth creation.
3. Time in the market remains superior to timing the market – so remain invested for as long as possible.

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Guiding our perception of risk is crucial to achieving our financial goals

Like a pen and paper, soap and water and salt and pepper, so too risk (and reward) goes with all investments. Carl Richards points out in his blog – “Risk is what’s left over after you think you’ve thought of everything”. He goes on to explain that investors are good at managing and dealing with risk by looking backward and preparing themselves to deal with a situation they have already seen, only better this time. But we’re not good at preparing for something we can’t imagine.

If we could count on riskier investments to produce higher returns, would that not mean that it would not be risky in the first place?

Consider this example: If you buy something for R10 and sell it a year later at R20. Was it risky or not? Some might argue that the profit you made proves it was safe, while the academics would say it was clearly risky since the only way to make a lot of money (100% in this case) is to take a lot of risks. Both sides of the coin could be true – it could either have been a very safe investment that was sure to double or a very risky lottery bet.

We all have to deal with the fact that we just don’t know how the future will play out, especially when it comes to financial markets. All investments have risk but these risks come in many shapes and forms, and guiding our perception of risk when it comes to investing is crucial to achieving our financial goals.  

What is risk?

“Investment risk is the possibility that an investment’s actual return won’t match its expected return.” Risk means different things to different people. Some investors could see risk as a drawdown, as we saw in March 2020. For others, risk could be underperforming the index or even underperforming a peer group average. Investors also have different levels of risk tolerance.

The most common definitions of investment risk are rooted in uncertainty. What is the likelihood of the returns on my investment deviating from the expected returns, and by how much? There are a variety of ways to measure this likelihood, the most common measure being volatility or the standard deviation of returns.

Volatility (standard deviation) helps investors understand how extensively returns could fluctuate from their average. It is a metric that is simple, widely accepted—but not helpful at all.

Standard deviation falls short in several ways –

• It treats downside risk (the bad kind) and upside risk (the good kind) as equals.
• Standard deviation doesn’t measure the shape of the distribution of returns. Meaning, if we look at all the return observations of a certain asset and/or asset class, how frequent are these return observations positive and/or negative
• It does not directly size the magnitude of unexpected events—those episodes that result in the greatest euphoria or fear.

There are a host of other definitions of risk that are far more important when we want to achieve our financial goals, let’s unpack some of these below.

1. The risk of opportunity cost

Opportunity cost creates the possibility that the return on a selected investment is lower than the return on an investment not chosen.

The below graph illustrates –

• • A hypothetical stock/bond portfolio, with different asset allocation weightings, over the past 20 years
  • For example, the 80-20 portfolio indicates an 80% investment in equity (FTSE/JSE All Share Index) and a 20% investment in bonds (FTSE/JSE All Bond Index).
  • The blue bar showcases the returns
  • The red bar showcases the volatility
  • The grey line illustrates the risk-reward ratio. The lower this ratio – the less volatile a portfolio has been in comparison to the return generated from the portfolio.

A couple of observations:

• • An all-stock portfolio has the highest risk/reward ratio but also produces the highest annualised return over the 20-year horizon.
  • The 60/40 and 40/60 portfolios have a very similar risk/reward ratio.
  • The risk/reward ratio increases as you move to an all-bond portfolio.
  • An investor would have benefitted from having at least 40 – 60% in equities as opposed to having no exposure to equities.

Although equities introduce volatility to a portfolio they also bring additional returns which is needed when there is a target to outperform inflation over time. The risk of not having enough risk in a portfolio can be detrimental to a long-term financial plan.

2. Concentration risk

This is likely where the phrase “don’t put all your eggs in one basket” is most appropriate – due to concentration risk in investments. No asset class has a perfect strike rate and performs well all the time. It is also very unlikely that every asset class will perform well at the same time. It is for this exact reason that diversification within a portfolio is key.  

The most important rule of trying to manage risk is to have different assets and/or asset classes that are drivers of return in an investment portfolio at different times and in different market environments. This strategy is designed to capture opportunities in strong market environments and provide downside protection in weaker ones (in other words, when one asset under[1]performs, returns are protected and achieved by other asset classes that perform well when others might not).

The graph below shows asset class returns on a calendar year basis, and it is evident by looking at this chart that it is very difficult to predict which asset classes will outperform each year. Let’s use the first asset class “Global bonds” as an example – it most certainly wasn’t a sure bet and a fairly bumpy ride.

Similarly, when we look at managers within an investment portfolio it is very important to have different styles and managers who perform differently. As with asset classes, no manager has a perfect strike rate.

The below graph shows the top four performing general equity managers for 2022 (excluding FoF’s) ranked by year-to-date returns. It then shows the four bottom-performing general equity managers (excluding FoF’s) ranked by year-to-date returns. In addition, it also indicates their corresponding rank in the last six calendar years.

Let’s put these rankings into context.

• • Within the ASISA Equity General category, there are 101 funds.
  • If we look at Fund B as an example,

− This fund is the second-best-performing equity fund in 2022 and 2016. It was the fourth-best-performing fund in 2021.

− It was one of the worst-performing funds in 2020 and 2019.

• • Similarly, when we look at Fund F,

− This fund was the best performer in both 2016 and 2019 and the third best in 2021.

− It was also the worst-performing in 2017 and the third-worst in 2022.  

Blending managers with diverse styles who perform differently over time, rather than trying to pick the best-performing manager each year adds a lot of value to client portfolios.

3. The risk of falling short

The last risk is the one investors should be most concerned with because the risk of not reaching your financial goals has a much larger impact on your life and well-being than the volatility (standard deviation) of your returns ever could.  

High risk, high reward is a widely used phrase when it comes to investing. To be able to generate higher returns you need to be able to accept higher risk. The risk of falling short of your financial objectives is real and this can get amplified by investors being in the wrong strategy over their investment horizon.

Consider the example of an investor that has been invested in the wrong strategy for a long period of time.

The table below shows –

• • An investor who contributed R1 000 per annum for 30 years in different strategies.
  • These strategies range from targeting inflation (assumed to be 4,5% for this example) to inflation + 5% (your typical balanced portfolio strategy).
  • A very simple calculation will show you that over a period of 30 years –

− If you underperform by 1% – you end up with 17% less retirement capital.

− Increasing that to 3% (i.e. achieving inflation +2% rather than inflation +5%) equates to 43% less retirement capital. A more practical example would be the difference between investing in a cautious portfolio and being invested in a balanced portfolio.

− Ultimately, the proof is illustrated in the numbers – as can be seen in the bottom row.

Key takeaways

When thinking about risk you want to identify the thing that worries you and demands the most compensation for bearing and/or beating it.

What we know to be true is that:

1. 1. Risk in financial markets is unavoidable
   2. Having equity in a portfolio brings about volatility
   3. Having only cash brings about the risk of opportunity cost and not managing to keep up with inflation
   4. Being in the wrong strategy out of fear brings about the risk of falling short of your financial goals.

Don’t think about risk as something to be avoided altogether. A fundamental premise of investment theory is that to get returns beyond the risk-free rate, we must embrace some level of risk. A longer time horizon does not excuse us from the shorter-term volatility we experience over time but, riding out shorter-term volatility will give you a greater chance of overcoming your biggest risk which is not meeting your goals.

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Market volatility and how to train your brain

The pilot’s famous answer, when asked about his job, is, “Hours of boredom punctuated by brief moments of terror”. This applies perfectly to investing, with the brief moments of terror being the rise and fall of markets. We could argue that we have just lived through one of the worst nine-month periods in history, not only for stocks but also for bonds and even more so for the much-loved 60/40 (60% equities, 40% bonds) portfolio.

At this point in the market, investors may feel the need to understand every headline and the immediate impact it can have on their investments. And as we devour every article and/or watch every daily, weekly and monthly drop and rise in our investment portfolio, it becomes extremely important to know and acknowledge our behavioural biases.

What is worse – action or inaction?

Our minds take shortcuts every day when we make decisions. Like deciding to stick to a more familiar brand when buying an item. Usually, these shortcuts are for the better, they help us react quickly and help us manage the thousands of decisions we have to make every day.

There are times, however, when mental shortcuts are not helpful and tend to lead us astray, and that’s when they become biases. What is a bias? Behavioural biases are irrational beliefs or behaviours that can unconsciously influence our decision-making process.

Markets have been brutal and it might feel like they are only going one way, and that is down. Taking action seems like the only rational decision to make. A common bias is called the Action Bias, and is best explained by the sentiment of “well, at least I tried.” This common consolation can be comforting and justified in many decisions, but not in all circumstances.

In some situations, it can be better to do nothing. The chart below shows the effect of moving to cash during a market downturn, using the Global Financial Crisis as an example.

• An investor who capitulated and moved to cash during the Global Financial Crisis would have ended with an investment portfolio of $160 096
• An investor who stayed the course would have ended with an investment portfolio worth $523 740 The difference equates to $363 644.

In our minds, it hurts less to try something and lose, compared with doing nothing and losing anyway. During times of market volatility, if investors don’t calmly think about the appropriate course of action and give in to action bias, it can make losses objectively worse despite feeling subjectively better. It is important to acknowledge that inaction is also an active decision.

Investors are inherently loss averse, meaning we hate losses more than we love gains.

One of the most well-known and often-cited behavioural biases is “Loss Aversion”, and it too can be especially prevalent during market volatility. A 20% portfolio loss feels a lot more intense than a 20% gain for many investors and experiencing a loss generally feels twice as bad as gaining the same amount feels good.

This strong emotional reaction to losses and the need to “do something” can cloud our judgment during times of volatility and it is critical to acknowledge that losses are a part of a well-functioning market. If markets never experienced losses, they wouldn’t be risky, if they weren’t risky, they would get really expensive, when they get really expensive, they experience losses.

Learn to accept constant and guaranteed turbulence

Over the last 20 years, the average return for the S&P 500 and the All Share Index has been about 11% and 15% in rand terms. Investing our hard-earned money in the stock market would be a lot simpler if we could rely on earning 11-15% every year without any volatility. But that is not the reality, throughout our investment horizon we will have to endure constant and guaranteed volatility.

Historically in both local and global markets, every year has had a “moment of terror” or drawdown and the chart below looks at the S&P 500 annual returns in the blue bars and the maximum drawdown of each year in the red dot. The maximum drawdown shows the movement from the highest peak of the market in that year to the lowest point. This chart shows that every single year of the 35 years had a maximum drawdown, while only 10 of the 35 years ended the year in negative territory.

The four most expensive words in investing are likely to be “this time it’s different”

During a boom, greed dominates. After the crash, the residual emotion is fear. If we look back to March 2020 it was the most volatile month since the Great Depression. An overwhelming amount of headlines read, “this time it is different”, this was a pandemic, unprecedented times, markets would take years to recover, if they would ever recover. But, it was the fastest recovery we saw in stock market history.

During the sell-off in 2020, we reached a bottom in the market on the 23rd of March 2020. Historically it has taken the market about two years to recover from a drawdown of this magnitude. This time it happened in 149 days and at the end of August 2020, the market had already reached new highs.

Now that we look back, it seems obvious that the market would recover.

Hindsight is 20/20

Many events seem obvious in hindsight, this is called Hindsight Bias. This bias tends to occur in situations where we believe (after the fact) that the onset of some past event was predictable and completely obvious, whereas in fact the event could not have been reasonably predicted. Identifying when things really are different and when the collective madness of the crowd is in full force is the difference between sitting out a market rally or participating in it.

In an article by Morgan Housel, he speaks about how important it is to remember that most of our lifetime investment returns will be determined by decisions that take place during a small minority of the time. Most of these periods come when everything we thought we knew about investing is thrown out of the window.

We all know to expect things like market volatility and inflation, but the emotions we feel while they occur can be even more dangerous than the market movements themselves.

Carefully consider both sides of the argument

Learning to embrace the downturns is easier said than done. We tend to seek out information that supports our beliefs, such as that the stock market will never recover, rather than seek information to the contrary. This is Confirmation Bias in action.

Let’s consider an investment example of confirmation bias. It is December 2015 in the midst of Nenegate, the finance minister had just been fired, the 10-year bond yield had just hit a record high of 10,4% causing a sell-off in the bond market and the rand depreciated to more than R16/$.

You feel strongly that South-African bonds are set to experience significant losses, and the rand will continue to weaken, the economy is on the brink of collapse. You seek out every news headline and/or research that confirms your belief and you plan to move your fixed-income holdings to cash as a result.

Right before you make the change, your financial adviser shows you the probability distribution of historical bond yields and points out that South-African government bonds are offering attractive value at this point in time. When presented with this data, you say to yourself, “This is crazy. This would never happen” and you move ahead with changing your portfolio.

What happened in the next two years, between January 2016 and March 2018? South-African government bonds returned 15,23% annualised while cash returned 7,45% annualised over this period.

Remember to consider both sides of the market noise and movements when reading the news or looking at your investments. It might seem like the only decision is to move to cash during times of market volatility, but as we’ve shown above, the other side of the argument proves much more prudent.

Switch on autopilot and sit tight

For investors, it is critical to acknowledge these biases and make good decisions in volatile times. Making big changes when there has been no change in your time horizon, circumstances or needs can be detrimental to your long-term financial plan. Stay on autopilot during the turbulence.

When stress and anxiety are high, it’s easy to give in to our biases and let them cloud our better judgments. Research shows that understanding our biases can help us spot them in our decisions which can add immense value to our financial plan over time.

When you find yourself questioning your investments, and being down and out about the market, set up some time to speak to your financial adviser, who will be best placed to paint a realistic picture for you of what is really transpiring in markets and what action – or rather inaction – would be best suited to your unique investment needs.

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

There’s an old saying in the world of fitness – “summer bodies are made in winter”, meaning that, although it is common for us to let our fitness regime slip in winter, it is actually the season we should be using to get our bodies in shape for summer. If one had to apply the same logic to finance, it could be something like Oscar Wilde’s quote – “when I was young, I thought that money was the most important thing in life; now that I am old, I know that it is.”

Now and then we all get a little complacent with life. Sometimes we exercise less during the cold winter months, and we eat a little more comfort food. The best of us sometimes lose sight of our goals (whether it is health, career or finance related) or maybe we get lazy with things like budgeting and saving. In South Africa, 1 September is known as Spring Day, signaling the approaching change in season from winter to summer. This time of year is known to act as a trigger for people to tackle their annual “spring cleaning” ritual – they get rid of old or unused items, deep clean the house, and do some general reorganizing. It is also a time when people start questioning their fitness routine, spending more time outdoors and unpacking and trying on those summer clothes again. I would like to suggest that we all start the habit of using Spring Day, as a day to trigger the reassessment of our savings as well.

It’s been an extremely challenging decade for many South Africans, and it is okay to feel exhausted, emotionally, and physically. It is okay to feel a little run down and behind in your goals. The wonderful thing about spring is, that it reminds us that life continues. New flowers will soon bloom, the sun will shine a little longer as each day goes by, and the temperature will start to rise. Seasons do change, and so can we. Spring is the perfect time to dust off your financial plan and re-assess whether it requires some tidying-up. Now more than ever is important to get back into financial shape. 

Back to the basics

A good starting point to get back into financial shape is to take stock of where you are. Make a list of all your assets, liabilities, monthly income, and monthly expenses. This will give you a good indication of what your financial position looks like and it is important to be honest with yourself here.

• Assets refer to anything that you own, for example, property, investments in shares, unit trusts, money that is owed to you, and cash in the bank.
• Liabilities refer to your debt, outstanding payments and loans – for example, your home loan/bond, car loans, student loans, credit card debt, etc.
• Income can include your salary, rental income, interest, and dividends earned.
• Expenses include all your fixed expenses – for example insurance payments, levies, medical aid, as well as variable expenses (like groceries and electricity).

Start with the end in mind

When you know what your goal looks like, it is much easier to visualize and plan how to achieve it. Make sure your goal is well-defined, obtainable, and realistic. For example, if you want to lose 10 kilograms over the next couple of months, your plan will look very different to that of someone whose goal is to run a marathon. Although being fit and healthy are the ‘means’, the end is very different. Know what you want your end to look like.

Perhaps it is a comfortable retirement, perhaps it is saving enough to start your own business. Whatever it looks like, it’s important to establish clear goals so that you know exactly what you are working toward and what you need to do to get there.

Budget, budget, budget

You can’t identify your healthy (and unhealthy) financial patterns until you put a budget in place. Your budget is essentially a plan for how to spend your money each month. Look at your spending over the last few months (or compare the same month with that of a year ago) to get an indication of what you usually spend in each category. There are many budgeting templates available online if you get stuck.

In the wise words of James W. Frick – “Don’t tell me where your priorities are. Show me where you spend your money and I’ll tell you what they are.”

The key to setting up a successful budget – even for a beginner – is that you must monitor how far you are sticking to or deviating from your budget. Keeping track of your monthly income and expenses against your budget will give you a much better view of where your money is going, show you where you are overspending and/or where you are saving. That brings me to the next point.

Spend what is left after saving – pay yourself first

Saving should be part of your budget. The easiest way to prevent yourself from spending what you should be saving is to set up a monthly debit order and let it do the work for you. Warren Buffett’s words will always ring true – “Don’t save what is left after spending but spend what is left after saving”.

You can use your annual tax-free savings contribution allowance of R36,000 (that’s up to R3,000 per month), increase your retirement annuity contribution and/or save by using other products available at your disposal, such as unit trust investments.

It is important to note that, it’s the habit of saving that matters most, and less so the actual amount. Of course, the more you save the better, but getting into the habit can be the hardest part. You will be surprised how rewarding it is to see how quickly you can build up a nest egg and the incredible power of compounding.

Have you invested appropriately for your risk profile?

As we enter new or different phases in our lives, our risk profiles can change. It is a good idea to take stock of all your investments and do an asset allocation check on an annual basis. Have you invested appropriately for your risk tolerance, time horizon, age, and financial circumstances? Do you have enough offshore exposure? Perhaps you have been de-risking too much or taking too much risk.

Tax

A small word that often evokes big emotions is ‘tax’. Whether we choose to talk about it or not, the reality is that tax is inevitable. What you can do as part of your spring-cleaning exercise is to get a professional to assess whether your financial plan is structured in the most tax-efficient way possible.

In addition, tax return season is open – SARS has announced that their filing season will run from July 1 to October 24 for individual taxpayers, so get those tax returns filed nice and early.

Insurance and risk policies

Perhaps part of reviewing your financial plan should be to do a check to ensure that all your short-term insurance, medical aid, and other policies (for instance life cover, disability cover, severe illness, etc.) are still relevant and accurately reflect details about your circumstances and beneficiaries. Consider if it is time to add or remove policies. 

Will

As part of cleaning up your act and getting back into shape, consider having a look at your will. Do you have one? Is the information, assets, beneficiaries, etc. still relevant and applicable? What can you remove and what should you add?

Consider your emotional well-being as well

Most definitions of financial health are very one-sided. It often focuses only on economic or financial stability. Ignoring your emotional well-being could be a recipe for disaster.

Being financially healthy is not just about having enough money to cover your expenses—it’s also about feeling emotionally at ease with your finances. People who feel empowered in their financial lives also experience more joy, peace, satisfaction, and pride concerning their finances.

Conclusion

Getting back into shape can be a daunting task, so take it one step at a time. It is recommended that you review your financial plan at least once a year (barring any life-changing events that might take place in between, such as getting married, having a child, losing your job, etc.). If you haven’t done so in a while, don’t lean into the temptation to bury your head in the sand and ignore the issues that might exist – the solution is often more achievable than you think.

The key to being successful is to stay motivated throughout the process. Now and then you are going to have a setback. You are going to give in and eat that decadent slice of chocolate cake and/or dread your next workout. And that is okay. As long as you keep doing your best and get back on track as soon as possible.

Share your goals with your financial adviser and family to keep yourself accountable, break down your goals into smaller steps, and reward yourself when you hit major milestones. With patience and commitment, you can improve your financial situation and rest easier about your future.

Raoul Gordon

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

It’s been an interesting year for investors. Given the state of the global economic outlook, there has been a lot of talk of an impending recession, or even that we’re already in one. Understandably, this may leave you feeling nervous. Recessions may elicit fear in us, as we might expect a slower economy to affect both our portfolios (through lower investment values) and broader lives (through less income or a job loss). The implications of a recession tend to play games with our emotions and often drive us to make bad decisions.

What exactly is a recession? The technical definition is two quarters (six months) of negative economic growth, measured by a declining gross domestic product, or GDP. GDP is the total market value of the new goods and services produced during a specified period. More simply, a recession describes a shrinking economy rather than a growing one.

As counterintuitive as it may sound, recessions can be a great time for investors, because prices can become lower than they normally are. That gives your investment manager an opportunity to buy assets more cheaply and, in so doing, sow the seeds of future growth. The problem is that recessions create uncertainty around the future and thus it does not feel like a great time to invest, so some investors are tempted to pull money from their portfolios. This typically leads to selling at depressed prices, locking in losses.

The best thing we can do is to be prepared, should we find ourselves in a recession, by having a few rules in place to help us make better decisions and know what to do. Here are a few habits that can help protect your savings in a slowing economic environment.

1. Take some time to make sure your financial position is secure. In a recessionary market, it’s a good rule of thumb to make sure you have a cash buffer and that your portfolio includes exposure to assets that can thrive in a depressed environment. If you are unsure about this, take some time to check in with me to make sure your total financial position is still appropriate for your goals.
2. Remember the rules of wealth attainment. Namely, save early and often, and invest your savings in a portfolio that reflects your risk tolerance. Then let the power of compounding grow your wealth faster than inflation. In a recession, fear may drive some people to stop saving and/or choose a more cautious portfolio. But, as we’ve said, some of the best returns historically have been recorded during rebounds from recessions. Taking a break from markets can mean missing out.

Given the current environment, staying invested can be easier said than done. I encourage you to give me a ring if you have any concerns, or if your financial situation has changed and you think that warrants a rethinking of your investments. Regardless, save every little bit you can, as we’ve discussed.

3. Don’t sell out. We all know the old adage, “Buy low, sell high”. Yet, when fear drives you to move to a more conservative portfolio, you sell stocks low (again, locking in losses) and buy bonds high (increasing the chance that they’ll return less or even lose money over the long run). The start of a recession is not the time to liquidate your investments. Depending on your time horizon, you most likely have enough time to ride out short-term stock price drops if you stay focused on the long term.

A recessionary environment could even be a time to increase your contributions to your portfolio. By saving when the market is down, you’ll likely buy low. This brings me to my next point.

4. Stay the course by averaging in. With uncertainty in the air, holding together your finances can be tough. Therefore, it’s a good idea to set accounts on autopilot to avoid the temptation of hoarding cash under your mattress. Automated savings plans take the guesswork and hesitation out of your present self and help attain your financial goals.
5. Think long-term and keep concentrating on your goals. It’s important at all stages of the market cycle to think about the goal of your investment portfolio. Ignore short-term performance in favour of your progress toward your goals. If you do that consistently, it’s really going to help you to continue investing through this or any recession.

Above all, let’s remain focused on the long term and avoid being spooked by the “R word”. We should all expect at least one recession over our investment horizon (likely many more) so we should try to make the most of it.

As always, please let me know if you would like to discuss this or anything else in more detail.

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

On 23 February 2022, Finance Minister Enoch Godongwana delivered the annual budget speech, providing an update on South Africa’s finances. 

Low economic growth, vast unemployment, increasing debt levels, coupled with South Africa still being in a state of disaster two years since the start of the Covid-19 pandemic, all contributed to a complicated juggling act for the Minister of Finance. 

Given the unrest witnessed in 2021 along with weak foreign investment, the 2022 budget had to be geared not only to curb unemployment and to stimulate economic growth, but to also give assurance to foreign investors. 

In the words of Minister Godongwana “we need to strike a critical balance between saving lives and livelihoods, while supporting inclusive growth. This budget presents this balance”. 

 Some key aspects to consider that has affected spending potential and therefore, economic growth: 

• An already high unemployment rate that was exasperated by Covid-19. 
• A lot of companies had to implement retrenchments and/or salary cuts, leading to lower household income and therefore lower spending. 
• Lower income levels also directly impact the amount of personal income tax and VAT that is gathered. 
• Inflation has increased to 5.7% – placing increased pressure on low-income bracket tax earners. 
• The emigration of highly skilled workers has increased. 
• Higher commodity prices, which supported the economic recovery, slowed in the second half of 2021. 
• Industrial action in the manufacturing sector, and the re-emergence of loadshedding, also slowed the pace of the recovery. 
• Continued requests for financial support from financially distressed state-owned companies. 

According to Minister Godongwana, “only through sustained economic growth can South Africa create enough jobs to reduce poverty and inequality; enabling us to reach our goal of a better life for all.” 

 Revenue, deficits, and debt to GDP according to the 2022 budget: 

• Tax revenue for 2021/22 is estimated to be R1.55 trillion, exceeding the original budget estimate by about R182 billion. 
• Higher income levels have been primarily driven by the resources sector due to increases in commodity prices. 
• The budget saw higher revenue from other sectors and other tax instruments, such as personal income tax, value-added tax followed by corporate income tax. 
• Government debt has reached R4.3 trillion and is projected to rise to R5.4 trillion over the medium-term. 
• The consolidated budget deficit is projected to narrow from 5.7% of GDP in 2021/22, to 4.2% of GDP by 2024/25. 
• The debt ratio will stabilise at 75.1% of GDP by 2024/25 (which is 3% lower than projected in the MTBPS). 

Below is a quick overview of some of the key updates announced in the budget speech: 

Tax credits and rebates: 

Levies, duties, and charges: 

Other areas of tax collection that were introduced and/or increased for the first time in a while: 

Disclosure of wealth will be required to assist with the detection of fraud 

To assist with the detection of non-compliance or fraud through the existence of unexplained wealth, it is proposed that all provisional taxpayers with assets above R50 million be required to declare specified assets and liabilities at market values in their 2023 tax returns.¹ 

Retirement fund taxation and reform on the cards 

Changes have been proposed to allow for greater investments into infrastructure funds by Regulation 28 compliant funds. Amendments to Regulation 28 are expected to be gazetted in March 2022. 

There are proposals to allow members access to one-third of their retirement fund savings while the two-thirds balance must be preserved for retirement. The tax consequences of these changes are still being considered. The draft legislation on these amendments will be published for comment in the middle of the year. 

In conclusion 

Given the endless stream of hardships that South Africans have had to face since the outbreak of Covid-19 and its devastating aftermath, the 2022 budget was expected to be consumer-orientated, and it has delivered on expectation. Given the fragile state of the economy and the country’s growing debt burden, National Treasury faced a difficult balancing act between providing the necessary relief to consumers and businesses while also taking steps to improve the country’s fiscal metrics. 

Minister Godongwana shared this view and stated, “…in these trying times and without compromising our ability to collect revenue, we have managed, through these tax proposals, to keep money in the pockets of South Africans, and to create conditions for greater investment in the economy”. 

According to Treasury, if the personal income tax brackets were not adjusted, revenue would have increased by R13.5 billion. This relief is mainly targeted at individuals in the middle-income group. 

The government’s main task will remain to create jobs, to ensure that we continue to grow and stimulate the South African economy and to keep government spending low. 

Perhaps the most crucial element of the budget was the continued commitment to the fiscal stabilisation programme, with the restriction on increases in public sector wages being a vital component. As we have seen from previous budgets, implementation risk is high, given the politically unpopular move of restricting wage increases. This restriction is likely to continue to be contested by labour unions. Fiscal prudence going forward will be essential if South Africa is to avoid a debt trap in the medium term. 

Useful links and resources: 

• Budget 2022 Highlights 
• Budget 2022 Tax Guide 
• 2022 Peoples Guide (English) 

1 Source: http://www.treasury.gov.za/documents/national%20budget/2022/review/Chapter%204.pdf

 Michael Kruger

Investment Analyst
Morningstar Investment Management
South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

At face value, it appears as though markets have performed well, however, broadly speaking there have been some landmines that simply could not have been avoided by all investors. 2021 was also by no means a dull year – global bonds bottomed out, the Evergrande debacle, Chinese tech stocks slumped and the contagion of it all to emerging markets. 

 If we look at the various asset classes across the calendar year, the first point that stands out is the broad positive returns across all the nine asset classes in 2021 (as can be seen in the chart below). The second is the rotation in the ranking, highlighting the importance of diversification.

 Looking at local markets in 2021 

•  S.A. Equities are making a comeback
  After a seven-year drought of returns for domestic equities, the past 18 months have seen a strong rebound in S.A. equities with broad-based returns across the sectors. While 2020 saw resource shares (mainly platinum and diversified miners) performing well, 2021 saw a rotation into more unloved areas of the market. Looking back at 2021, the strongest performing areas were what we would term “S.A. Inc.” shares, namely banks, retailers and select industrial shares. 

  What caught many investors by surprise in 2021, was the sharp fall in the Naspers and Prosus share price. Market darling Naspers, combined with Prosus (its European listed counterpart) account for almost 20% of the All-Share Index. A combination of concerns regarding the Chinese government’s interference in their market with regards to the new regulation for select tech companies alongside the disappointment surrounding the Naspers Prosus share swap and/or company restructure has proved to be strong headwinds for these shares.

   

• Fixed Income, wasn’t so ‘fixed’
  Fixed income managers did not have an easy year, with 2021 not being the year for income assets. What had appeared to be a stable (and dare I say “boring” asset class) was no more, as 2021 saw fixed income assets experience a lot of volatility.

   

• S.A. Government bonds bamboozled
  S.A. Government bonds remain perplexing. We are seeing good value in this asset class, with S.A. government bonds offering a yield of around 9.5%. This is almost 5% ahead of cash and 4% ahead of inflation, which is unheard of in global markets. Yet despite this attractive yield, foreigners have not been investing in our bond market to the levels they have previously. As a result, this asset class is generating a decent yield for investors but has been subject to market volatility this year due to the lack of foreign support.
   

• Cash is still out in the cold
  We see little room for holding cash in portfolios. Not only is the nominal yield low (around 4%), it is in fact offering a negative real yield, given that inflation is close to 5%. 

Turning to global markets, it seems nothing could stop this bull. 

While value shares and unloved sectors (such as energy and UK equities) certainly rallied and were solid contributors to portfolio performance, the tech stocks in the US reached stratospheric levels (both in terms of performance and in price). 

In our opinion, this sector is starting to carry a striking resemblance to the tech bubble of the late 90s. Firstly, the market is trading at extreme valuations and is experiencing new IPO’s (stock listings) in the magnitude last seen in the late 1990s. (If it walks like a duck and talks like a duck…) We prefer to be cautious at this point. We remain materially underweight US large-cap tech shares. 

Despite emerging markets selling off sharply on the back of the Chinese government’s interference in capital markets and the restrictions and regulations placed on their tech companies, we are seeing good pockets of opportunity in emerging markets. 

It was not only S.A. fixed income managers that had a tough time in 2021; global fixed income managers had it even worse. Global bonds were one of the worst performers in 2021. With starting yields at low levels and bond yields rising throughout the year, this led to bondholders experiencing meaningful capital losses. 

How have we positioned Morningstar portfolios? 

Our Morningstar capital markets work guided us to have meaningful exposure to domestic equities, with an overweight allocation to the S.A. Inc. shares (which benefitted portfolios). We have always had an implied 10% cap exposure to Naspers and Prosus combined, which also helped limit drawdowns as this share fell. I have to say that for the years that this share drove returns, the implied cap we held in portfolios resulted in a contained drag on performance. Nevertheless, risk mitigation is key. We are prepared to forego some upside in order to protect on the downside. 

We have remained fully invested offshore with the majority of this allocation being held in global equities. This allocation has been a solid contributor to performance as we have captured the returns from global equities markets, despite the rand zigzagging between R14.50/$1 – R16,50/$1. We have a healthy exposure to emerging markets which detracted marginally from performance; however, this remains a high conviction allocation looking forward. 

Our meaningful exposure to S.A. government bonds has not provided the returns we had envisaged, however, when compared to cash, it has been the right decision. We remain confident in this holding as we expect interest rates to rise in 2022 (albeit in small increments) and this should be beneficial for long-dated government bonds. 

Looking forward – onwards and upwards into 2022 

Overwhelmingly, the so-called “TINA Theory” narrative from 2021 is still alive and well as we enter 2022. For a while now, the TINA – “There Is No Alternative” – Theory, has been used as the reason or basis for why the current bull market simply won’t quit. 

The fact that we have very low cash yields and very low global bond yields has pushed investors towards riskier assets such as stocks, which seemingly continue to go up (and up, and up). Let’s not forget that equity markets looked fairly expensive going into 2021—and many key markets are again looking expensive going into 2022. 

In the wise words of Warren Buffett – “Be fearful when others are greedy and greedy when others are fearful”. There is much exuberance, easy money and excitement in certain areas of the market. This level of optimism and crowding makes us “fearful”. 

There will be good news stories for companies and sectors that will be extrapolated into the future with investors prepared to pay extreme prices just to own these golden companies. Remember that “Price is what you pay, but value is what you get” – another valuable lesson shared by Mr Buffett. Now is the time to be vigilant and to ensure that you are getting value for what you buy. 

At Morningstar, we are certainly seeing attractive opportunities in select areas of the market. While we have a healthy exposure to select equities (both domestic and global) we also retain our holding in S.A. government bonds in favour of cash and global bonds. As a result, our portfolios are constructed to invest in areas where we see good long-term upside but also to ensure that risk is considered and there is a balanced exposure to both growth and income assets. 

You may not know if you should choose heads or tails, but at least you have the coin. 

You may hear some commentators saying that “markets are expensive and now is not the time to be invested” whereas others say that “things will just keep going up”. To this we would say there is never a “right time” to invest, the key is just to be invested and to remain invested. 

To quote Morgan Hounsel “Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key. 

And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance. “ 

As you reflect on the year that was, you can be pleased knowing that you remained invested and that you now have more wealth than you did this time last year. The seasons will inevitably keep changing, and so too the seasons for asset classes. This is exactly why your portfolios are being actively managed to ensure that as markets change, your investment changes to take advantage of the next cycle. All you need to do is stay invested and let the magic of compounding do its work. 

Victoria Reuvers

Managing Director
Morningstar Investment Management
South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.