The Consequences of a Market Correction

I have a confession to make.

I just can’t get myself worked up this Evergrande story.

Some markets people are comparing this Chinese property developer to Lehman Brothers or Bear Stearns.1

But if we’re being honest here 99.9% of investors had never heard of this company before they showed up in the headlines last week. And how many investors actually understand how the Chinese government is likely to handle all of the debt on this company’s books?

You can read all of the stories and listen to all of the podcast explainers but is it really going to help you become a better investor? Is this company really going to impact your ability to reach your financial goals?

Maybe I’m just over the fact that we’ve been swatting away potential canaries in coalmines for years now when the majority of them simply haven’t mattered.

Or maybe it’s just that I’ve resigned myself to the fact that market corrections can and will happen and the reason is mostly irrelevant.

If you’ve been reading this blog for an extended period of time you’ve read all of my market correction stats.

  • The average peak-to-trough drawdown for the S&P 500 in a given calendar year since 1928 is around -16%.
  • There have been 53 double-digit drawdowns overall in this time frame.
  • The average loss for those corrections is -23%, lasting more than 200 days from peak to trough.
  • Over the past 93 years the U.S. stock market has fallen 20% or worse on 21 different occasions.2 That’s once every 4-and-a-half years.
  • It’s fallen 30% or worse 13 times or one out of every 7 years.

Of course, there’s a big difference between averages and reality.

The stock market fell 50% from 2000-2002. It repeated that feat just 6 short years later.

From 1940-1968, there wasn’t a single bear market in excess of 30%. Then over the next 6 years it happened twice.

There are also some years in which there are no corrections. In 34 out of the past 93 years, there was no peak-to-trough drawdown that reached double-digit levels in a calendar year period (it hasn’t come close this year just yet).

On 7 different occasions, there wasn’t even a 5% correction in a given year (most recently in 2017).

From 2007-2011, the average peak-to-trough drawdown in the S&P 500 each year was -24%. Then from 2012-2017, it was just -8%.

There are ebbs and flows to these things.

It’s also true that each time there is a correction there is a different reason.

Sometimes it’s macro-related. Sometimes it has to do with market fundamentals. Sometimes it’s geopolitical in nature. Sometimes investors are simply looking for an excuse to sell after experiencing large gains. Sometimes the downturns feel completely random.

Most of the risks investors worry about don’t occur. And even if they do occur, they don’t match up with the time frame you’re worried about them occurring.

Markets are hard.

Now, just because this Evergrande story will likely never morph into another Lehman or Bear Stearns moment doesn’t mean it won’t impact certain investors or investments. It still might lead to some damage.

The question is: Does it matter?

If you measure your time horizon in years and decades, you’re going to be dealing with many more corrections along the way. At times, a large portion of your portfolio will seemingly vanish (for a time at least).

I suppose you could try to predict every geopolitical, macro and fundamental story in the years ahead to figure out how it will impact the market. But the odds show even if you could predict the headlines, you’ll never be able to predict how investors will react to those headlines.

And even if you could predict the direction of the markets over the short-term, you’ll never be able to predict the magnitude or length of those moves.

And even if you happen to nail the timing on the next correction, you’ll likely never be able to do it again.

My point here is market corrections are going to happen whether you know the reason or not. It’s not an if, but a when.

And since no one can figure out the when with consistency, the only thing you can do is recalibrate your portfolio or expectations ahead of time.

Either you learn to live with volatility or make your portfolio durable enough to better withstand the bursts of volatility.

This is true if we’re living through the next Lehman moment or a minor dip we all forget about in 3 months.

1There have been dozens and dozens of “Is this the next Lehman?” stories since 2008.

2It is worth noting the S&P 500 has fallen 19% and change on 5 different occasions since 1928. Oh so close to a bear market but not quite.

Source: https://awealthofcommonsense.com/2021/09/the-consequences-of-a-market-correction/

Ben Carlson

Director of Institutional Asset Management at Ritholtz Wealth Management

What else is on investors’ minds?

In August we addressed four key questions raised by financial advisors and their clients: What are the alternatives to cash? How much should you invest offshore? Is it too late to invest in South African equities? Are we seeing a change in investment style leadership?1 The article raised several additional questions from advisors, which we discuss briefly below. Please note that we have addressed each question independently, and not with a subsequent answer building on the prior question.

1. Can you do both good (make an impact) and well (generate investment returns)?

In short, yes. But why, and how?

There is growing consensus that the world needs to urgently address climate change, and that accelerated investment is needed to ensure global temperature increases stay within two degrees Celsius. Unfortunately, even a two-degree increase will have a massive impact on our planet. For example, coral reefs will be almost entirely wiped out; people will be exposed to more extreme weather (heat waves, droughts, floods, and tropical cyclones); mountains will lose their glaciers and be more susceptible to landslides; more than 70% of the earth’s coastlines will see sea levels rise greater than 0.2 metres; and certain islands will become uninhabitable.

There is an approximate 90% correlation between carbonisation and economic growth, and therefore we need to change the way the economy works. As a result, the world will need to invest between $2.4 trillion and $4 trillion per annum in areas such as wind and solar capacity, electric vehicles, and battery production over the coming decades to meet this objective. And yet we are currently only investing in the region of $700 billion per annum. This transition has barely begun.

It is fair to say that we all know what the problem is, but what are the catalysts for change? We have identified three key drivers:

  1. Regulation: Countries around the globe are signing up to the net zero carbon pledge.2 The year 2020 saw new policy announcements across Asia and the US, and stronger commitments from Europe. In fact, 64% of global emissions are now covered by “net zero” announcements.
  2. Technology: Costs have fallen materially as technologies have improved in areas such as wind and solar energy generation, and battery pack production which has, for example, resulted in an exponential increase in electric vehicle sales over the past decade.
  3. Consumer behaviour: Surveys suggest consumers are concerned about climate change and, as a result, are increasingly comfortable that their investment solutions include a portion that is environmentally focused.

The Ninety One Global Environment Fund seeks to benefit from the new structural growth themes of renewable energy (solar, wind, clean power utilities, etc.), electrification (electric vehicles, hydrogen economy, heating and cooling, etc.) and resource efficiency (waste management, agriculture, factories, etc.). Our specialist knowledge and proprietary research help us identify the most attractive opportunities within the complex environmental sector. This approach has been rewarding for our investors, with the fund outperforming the traditional global equity benchmark, the MSCI All Country World Index (ACWI), by more than 16% per annum since launch in February 2019.3

The fund’s differentiated strategy means that it serves as a great diversifier to traditional global equity portfolios, including the Ninety One Global Franchise Fund, which has attractive ESG credentials given the types of companies in which it invests.

2. If SA cash is trash, what can be said of offshore cash?

Well, offshore cash is even trashier. For several years now, offshore dollar, sterling and euro cash investments or money market funds have delivered zero (or marginally negative after fees) returns. While offshore money market returns might improve at the margin should the US Federal Reserve and other central banks start to raise rates, they are unlikely to do so materially in the short to medium term. Investors need to look beyond the perceived safety of these offshore cash funds to earn attractive hard currency real returns.

Conservative investors should therefore take a slightly longer-term view and consider funds such as the Ninety One Global Multi-Asset Income Fund. The fund targets an attractive, resilient yield of around 4% per annum, as a significant part of the overall return. This higher yield reduces the dependency of returns on generating large capital gains, and the associated volatility. The defensive income anchor has also meant that since inception in July 2013, the fund has not delivered a negative calendar year return.

In an article,4 co-portfolio managers John Stopford and Jason Borbora-Sheen said: “Given the importance of income [as a dominant driver of most asset class returns over the long run], the decline in yields, [as evidenced in Figure 1], on most asset classes since the Global Financial Crisis, and the further fall during the COVID-19 crisis, appears to bode ill for conservative investors.” The good news, however, is that the managers are still finding attractive opportunities across a range of asset markets and securities.

Source: Bloomberg, BofAML, yields as at 31 August 2011 and 31 August 2021. 1 month deposit rates for cash; 10yr Government bonds – generic sovereign yields; investment grade bonds: BofAML Sterling Corporate & Collateralised All Stocks Index; BofAML US Corporate Index; BofAML Euro Corporate & Pfandbrief Index; BofAML Japan Corporate Index; High yield bonds: BofAML Asian Dollar High Yield Corporate Index; BofAML US High Yield Index; BofAML Sterling High Yield Index; BofAML Euro High Yield Index; Emerging market bonds: JP Morgan GBI-EM Global Diversified Index; JP Morgan EMBI Global Diversified Blended Index; JP Morgan CEMBI Diversified Broad Composite Index; equity indices as stated. For further information on indices, please see the Important Information section.

It is these attractive opportunities that make their way into the fund. The managers are, however, selective in what to own and what to avoid, as the highest-yielding assets are often compromised and can deliver disappointing returns with significant risks. Better returns for less risk can generally be found in moderately high-yielding securities, where the yields are properly underpinned by resilient excess cash flows.

3. Global equity markets have run hard, now what?

While global equity markets appear expensive when looking at broad market indices, we believe that there are still unique opportunities for active stock pickers, as captured in the Ninety One Global Franchise Fund.

We believe that our Quality capability’s purist approach to quality investing is well suited to current conditions and for the uncertain times ahead. The team is solely focused on identifying attractively valued best-of-breed “franchise” companies with the following key attributes:

  • Hard-to-replicate enduring competitive advantages, for example, ASML (EUV lithography, DUV lithography)
  • Dominant market positions in stable growing industries, for example, Estée Lauder (brands include Estée Lauder, Bobbi Brown, Clinique and MAC)
  • Low sensitivity to the economic and market cycles, for example, Nestlé (brands include Gerber, Nescafé, Maggi, Nespresso, Purina)
  • Healthy balance sheets and low capital intensity, for example, Verisign (.com, .net)
  • Sustainable cash generation and effective capital allocation, for example, Visa

The result is a high conviction, concentrated portfolio of currently only 27 stocks. There is also very little overlap with the Top 50 MSCI ACWI stocks – only eight are included in Global Franchise and only two of these are in in the top ten holdings (Microsoft and Johnson & Johnson). In fact, the fund’s active share5 is 93%, meaning that the fund is highly differentiated from the MSCI ACWI and so is likely to also be very different from many other global funds, especially passive index funds.

Importantly, the companies in the Ninety One Global Franchise Fund are still generating far superior returns on capital, but are valued at a discount to the broader market.

Source: FactSet, Ninety One, 31 August 2021. *Index: MSCI AC World NDR (pre Oct-11, MSCI World NDR). The portfolio may change significantly over a short period of time. The above reflects the portfolio characteristics reweighted excluding cash and cash equivalents. Inception date: 30 April 2007. For further information on indices, please see the Important Information section.

Conclusion

Investors faced with one or more of the issues raised above may best be served by seeking professional financial advice, tailored to their individual circumstances.

Paul Hutchinson

Sales Manager

1. What’s on investors’ minds? This is the copyright of Ninety One and its contents may not be re-used without Ninety One’s prior permission.

2. Net zero refers to the balance between the amount of greenhouse gas the world produces and the amount removed from the atmosphere. Net zero is achieved when the amount produced is no more than the amount taken away. Reaching net zero is vital to avert the extremes of harmful global warming.

3. Source: Morningstar, 30 June 2021. Performance is net of fees (NAV based, including ongoing charges, excluding initial charges), gross income reinvested, in US dollars. Highest annualised return since its launch: 88.1% (31.03.21), A Acc USD. Lowest annualised return since launch: -7.3% (31.03.20), A Acc USD.

4. Thriving in an income desert, July 2020.

5. Active share is a measure of the percentage of stock holdings in a manager’s portfolio that differs from the benchmark index.

Important information
All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium- to longterm investments and the manager, Ninety One Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class.

Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.ninetyone.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, RMB, 3 Merchant Place, Ground Floor, Cnr. Fredman and Gwen Streets, Sandton, 2196, tel. (011) 301 6335. The fund is a sub-fund in the Ninety One Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act. Ninety One SA (Pty) Ltd is an authorized financial services provider and a member of the Association for Savings and Investment SA (ASISA).

Investment Team: There is no assurance that the persons referenced herein will continue to be involved with investing for this Fund, or that other persons not identified herein will become involved with investing assets for the Manager or assets of the Fund at any time without notice.

Investment Process: Any description or information regarding investment process or strategies is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective.

Indices are shown for illustrative purposes only, are unmanaged and do not take into account market conditions or the costs associated with investing. Further, the manager’s strategy may deploy investment techniques and instruments not used to generate Index performance. For this reason, the performance of the manager and the Indices are not directly comparable. MSCI data is sourced from MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

This document is the copyright of Ninety One and its contents may not be re-used without Ninety One’s prior permission.
Ninety One Investment Platform (Pty) Ltd and Ninety One SA (Pty) Ltd are authorised financial services providers.

Running the Rand race? Best you put away your timer if you are…

It’s interesting how the value of the rand can influence our perception of the value of our country. A strong rand, when compared to the dollar, often makes us feel better about the state of affairs in South Africa. When the value of the rand climbs, so does our optimism about the growth and recovery of the country, while a weak currency fires up all the negative sentiment we read about in the press.

With that said, it’s not all doom and gloom and South Africans can find some reprieve in knowing that the value of our currency is only partially affected by South African specific factors. In the following article, we discuss the different factors that can influence the value of our local currency.

In recent years, the South African rand has been on the back foot against major currencies, with investors being extra cautious due to the many headwinds and political infighting that frequently dominates news headlines. Investors simply can’t ignore that the country has subdued growth, a weak fiscal outlook, rising industrial and social tensions, and external vulnerabilities associated with the current account deficit, all of which support a weaker currency.1

A research report2 was written by the International Monetary Fund (IMF) wherein it looked at the main drivers that impact the Rand/Dollar exchange rate since the onset of the global financial crisis and the results are very interesting.

Rand volatility could be attributed to global macro-economic factors

The IMF’s research showed that the main driver behind the movement of the rand relates to global factors and macro-economic events in the U.S. In other words, the level/value of the rand is often influenced and determined by dollar movement (strength and/or weakness). Roughly 30% of all rand volatility could be attributed to global macro-economic factors which influenced the US dollar and hence the rand.

As a small, open, emerging market that makes up less than 1% of the world economy, we are more likely to be affected by what is happening globally rather than in our own country. This is further exacerbated by the fact that the rand is one of the most liquid and tradeable currencies when compared to other emerging market currencies globally. Often when there is global risk aversion (better known as a “risk-off trade”) and investors flock to safe-haven assets, the rand acts as a proxy for all assets perceived to be risky by global investors. This can often lead to the rand depreciating.

1 Source: International Monetary Fund (IMF) “Surprise, Surprise: What Drives the Rand / U.S. Dollar Exchange Rate Volatility?” Data as at October 17, 2016.
2 Source: International Monetary Fund (IMF) “Surprise, Surprise: What Drives the Rand / U.S. Dollar Exchange Rate Volatility?” Data as at October 17, 2016.

Commodity price volatility is a key factor

A second finding was that commodity price volatility was a key factor that influenced rand/dollar volatility. Roughly 30% of the volatility of our currency was a result of commodity price volatility. Over the past year, we have seen a sharp rise in commodity prices of which South Africa has been a beneficiary.

South Africa is a net exporter of resources, and local exporters benefit from the rand weakness in that it makes the goods and services that we produce cheaper for foreigners and more attractive when compared to the goods and services available in other markets.

South Africa also imported a lot less in 2020, which has impacted our current account balance positively which, in turn, has been a factor causing the recent Rand strength.

Impact of domestic factors on the rand

The IMF’s research also looked at the impact of domestic factors on the currency. They found that neither domestic macro-economic surprises nor those originating from other emerging markets are statistically related to rand volatility. However, they did find that local political uncertainty is positively associated with rand volatility.

Purchasing Power Parity’s part

Of the many metrics used to determine the valuation of the rand against other major currencies, is the Purchasing Power Parity Index (PPP). PPP is an economic theory that compares the different currencies from countries across the globe through a “basket of goods” approach.

In 1986, The Economist created the Big Mac Index 3 to create a lighthearted way of showing PPP and whether currencies were cheap or expensive. The Big Mac Index uses a price of a Big Mac burger in the US (as a base) and then compares the price of a Big Mac burger in every other country (in its native currency) and then looks at the price differential.

According to the latest Big Mac Index data, the rand is very cheap compared to the US dollar. A Big Mac costs R33.50 rand in South Africa and US$5.66 in the United States. The implied exchange rate is 5.92. The difference between this and the actual exchange rate, 15.52, which suggests the South African rand is 61.9% undervalued.4

With that being said – it should also be pointed out that we do not believe the Rand to be 62% undervalued – this is merely a fun way of looking at relative currency strength or weakness versus the US dollar.

3 https://www.economist.com/big-mac-index
4 https://www.economist.com/big-mac-index

So, how should we go about working out a fair value for the rand?

Currencies can deviate significantly from fair value over time, however, over the long term, movements between currencies should reflect inflation differentials between two countries. Due to the relatively higher inflation environment in South Africa (especially compared to most developed markets), we would expect the rand to depreciate against most developed currencies in the long term.

Currencies can frequently deviate from purchasing power parity over time. Extreme examples include the height of the commodities boom in 2005 and 2006 when the rand reached R6 to the US dollar. Following the removal of previous Finance Minister Nhlanhla Nene (in late 2015 and early 2016) the rand reached around R17 to the US dollar.

What should be apparent, however, is the movement in the exchange rate following these events. In almost all cases, the exchange rate moved back to a value that would be regarded as fair when judged according to PPP. That is not to say that currencies do not stay cheap or expensive for long periods of time. Idiosyncratic events may cause currencies to deviate from fair value for extended periods, however, currencies tend to move back to levels reflective of inflation differentials in the long term.

As can be seen in the below graph, the rand is currently undervalued on a Purchasing Power Parity basis.

Work done by the capital markets team at Morningstar supports the view that the Rand remains undervalued compared to the US dollar. It is also worth remembering that the rand never really trades at fair value. Historically, the rand moved in big swings from being expensive to being cheap and each time shooting through fair value.

Where does that leave us?

While the rand (at roughly R14/$) is undervalued/cheap, we don’t believe the economic data supports a materially stronger rand. Over time the inflation and growth differentials between South Africa and our developed counterparts support a depreciating currency. While the commodity cycle and US economic factors favour a firmer rand for now, we do expect that in a 10-year horizon the rand is likely to depreciate from these levels.

We are often asked the question, “Is this the time to be taking money offshore given where the Rand is?” and the best way to answer that is to quote Howard Marks who said, “This is not the time but it is a time”. The decision to invest offshore should be based on the investment opportunity. While the value of the currency does play a factor, we would encourage investors not to try to time the currency.

The above factors once again emphasise the need for investors to remain patient, stay the course and avoid making investment decisions in a panic due to gloomy news headlines. This would include articles forecasting which direction the rand is heading. Previous experience has taught us that these forecasts are seldom accurate. It is during these challenging investment times that we should remove emotions from our investment decision-making process and focus on the fundamentals.

In Conclusion

Over decades of evidence and through the investment literature there is one golden thread –time in the market remains superior to timing the market.

Ask yourself this: “Given where I am now, what actions move me closer to my long-term goals?” “Would an investment change align with the original investment plan for reaching well-defined goals?” These are different questions than, “What do I wish I had done last month?”.

We believe that investing is a long-term pursuit, patiently allocating to assets that will help you achieve your investment goals.

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.

Tackling the frequently asked question – How are financial markets faring well when economies are shrinking?

The seeming disconnect between the performance of financial markets versus that of economies across the globe has left many investors scratching their heads. We often get asked how is it possible for financial markets to increase in value, but the economy is shrinking?

It goes without saying that we live in extraordinary times. The South African economy had never faced such an abrupt cease in trade and/or economic activity as with the commencement of the nationwide lockdown on 27 March 2020. The same can be said for other economies around the globe. As economies started to reopen, many investors have been left scratching their heads – the recoil in financial markets painted a very different picture from the economic outlook.

It is not surprising that markets experienced some of the sharpest falls in asset prices during the first quarter of 2020. The JSE All Share Index lost more than 30% from the start of 2020 until 23 March 2020. What was surprising to see was the speed of the recovery hereafter – since 23 March 2020 (the bottom of the sell-off), the market is up more than 70% (as at February 2021) making COVID-19 seem like a mere short-term disruption.

The economy, however, tells a very different story, with one of the largest contractions in GDP ever recorded, coupled with sky-high unemployment numbers.

How are financial markets flourishing when economies are falling apart? Let’s have a look at financial markets in more detail, more specifically the equity market.

 

Equity market

The equity market is forward-looking and prices of stocks/shares/bonds (any listed liquid instrument’s) are determined by the supply and demand of investors. Investors that are buying these instruments are expecting positive outcomes looking forward. Sellers, on the other hand, expect the price of the stocks/shares/bonds to decrease in value.

So how do you know if you should be buying or selling? Ultimately, you need to consider the value of the company. The intrinsic value of a company can be estimated by taking its future expected earnings and discounting the future cash flow with an appropriate discount rate to ascertain what the value of those future earnings are worth now (or at the time one buys the listed equity).

The factor that has changed most notably in the above equation is the significant drop in interest rates – not only in South Africa but globally as well. With interest rates decreasing with 3% since the start of 2020, the discount rate being used to calculate the worth of future earnings is now significantly lower. This will result in future earnings being worth more today than before the interest rate cuts.

When the economy is slowing, the South African Reserve Bank (SARB) cuts interest rates to stimulate financial activity. This benefits businesses in that they enjoy the ability to finance operations, acquisitions, and expansions at a cheaper rate, thereby increasing their future earnings potential, which, in turn, also leads to higher share prices1. The reduced financing cost also increases future earnings figures.

Companies also have control over aspects that contribute to the current value of the company. Companies can use times of uncertainty as justification to cut their cost base and in doing so increase their bottom line/earnings. In other words, the leaner operational costs will result in higher expected future earnings.

In short, market crashes reset valuations of listed companies and provide investors with the chance to invest into opportunities that might not have been available, or an even an option previously due to prices being too high. This ‘opportunity’ buying cycle subsequently drives up market prices.

The last factor that can’t be ignored, and one that is especially important in the South African landscape, is that listed companies that sell products offshore are not reliant on how the South African economy performs. These shares are more broadly known as Rand Hedges (with the weaker Rand also working in their favour).

If one looks at every company listed on the South African stock exchange (the Johannesburg Stock Exchange or JSE), the majority of companies are not reliant on the South African economy to generate earnings. These are companies with business interests that are either predominantly outside of South Africa or entirely outside of South Africa.

In fact, 69% of the revenue generated by the top 40 companies listed on the JSE was generated from outside of South Africa for the 2019 calendar year2. In essence, when you are investing in the South African equity market (as represented by the Top 40), only 31% of company revenues are reliant on the South African economy3.

This is possible due to the fact that some of the largest companies on our stock exchange are dual-listed companies. In other words, these companies are listed on more than one country’s stock exchange. For example – the BHP Group is listed on the London Stock Exchange as well as the Johannesburg Stock Exchange. While the BHP Group used to have operations in South Africa, currently the company does not generate any earnings in South Africa.

There are many similar examples on our stock market and most of these companies carry larger weightings in the index. We call these rand hedge shares. In short, if the rand weakens, it is a benefit to own these shares as they generate earnings in offshore currencies. So, as an investor, you are hedging your currency exposure even though you are investing in a South African listed equity.

 

Local government and economy

In contrast with forward-looking equity markets, Government GDP numbers are backwards-looking. GDP is the value of goods and services produced/rendered in a country during a certain period. It provides a snapshot of a country’s economy, and it is used to estimate the size of an economy and its growth rate.

Due to stringent lockdown rules in South Africa, several sectors came to a complete standstill and, therefore, did not contribute to growing our GDP rate. As an example, in South Africa, GDP numbers are highly dependent on mining, agriculture, manufacturing and construction (to name but a few) – most of which had to halt operations for quite some time. In addition, many of the companies that contribute to our GDP numbers are not listed entities but rather privately held and/or small business.

Unemployment is another number that has a different effect on economies when compared to listed companies. When a company retrenches employees it immediately lowers the expenses of the business and can potentially grow earnings (if income is unchanged) but the opposite is true for an economy. When someone is retrenched and they can’t find an alternative job, they move from being paid by a company to being paid by the economy and thus increasing the expenses of the government.

In closing

Investors too often redirect their attention away from the destination to the journey when faced with a lot of outside noise. Much like in other walks of life, we can lose focus, making us susceptible to capitulation or giving up at the moments when fortitude and resolve pay off most.

Patiently allocating to assets that will help you achieve your financial goals should remain key. So, if you catch yourself getting down about the state of our economy, or speculation around government policies or trying to predict what is next, always remember why you are investing in the first place.

There’s no doubt that the current market conditions are unsettling. It is at these moments that we would discourage investors from making changes that could harm their ability to reach their financial goals. It is often during these difficult times that we have the greatest opportunity to add value for our clients, acting rationally when others struggle to do so.

1 Source: https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/
2 Source: Ninety One Asset Management as at 31 May 2020
3 Source: Ninety One Asset Management as at 31 May 2020

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.

Has 2020 shifted your financial goals?

If this year has taught us anything, it is that we need to hope for the best, but plan for the worst. In financial planning, clients are advised to reassess their financial goals when faced with important life events and/or changes, such as getting married, having a child or with the loss of a loved one. This year, a significant event happened with the outbreak of COVID-19, impacting investors globally. As we approach the end of 2020 and the start of a new year, why not take the time to assess your current financial goals, whether these goals are still relevant, set new goals if needed and make sure you are set-up for success going into 2021.

 

As clients continue to deal with the stressors and worries caused by the pandemic, they may be having trouble making sound financial decisions. Research has shown that we all suffer from behavioural biases, and we can be even more prone to behavioural mistakes during times of uncertainty.

 

Uncovering your real goals

It is likely that 2020 has impacted investors livelihoods and financial circumstances, and thereby also their financial goals.

What are your top financial goals? As investors, we all face this question at some point, and we generally have an answer. But have you ever looked at how stable or consistent your answers are, when you think about them in different contexts or at different times? It may surprise you, but researchers have found that we tend to answer with whatever is top of mind, which may not always be our true, long-term goals.

For example, let’s say a friend recently read an article about vacation trips in Italy. When you ask about long-term goals, the response might be: “I’d like to travel more,” even though the person also cares deeply about leaving a legacy of charitable works. It’s not that the person is insincere or that other goals aren’t deeply held – it’s just that is what’s top of mind and easy to recall.

Tailoring your financial plan around your personal goals can both increase your total returns and motivate you to stay on track1. The success of this technique however depends entirely on having the right goals in place – which research suggests we, as investors, struggle to identify.

To prompt more-thoughtful goal identification, past research suggests that a carefully curated list —a master list — of common objectives can be effective. Master lists have been shown to improve preference identification across a variety of areas. Our research tested the effectiveness of lists for identifying financial goals. We wanted the answer to the question: How can we help investors identify their true financial goals, and not only those that are top of mind?

We found that many people seemed to prioritise goals that were more personalised, detailed, and emotionally grounded after viewing the master list, and the use of a master list also seemed to nudge investors toward more-specific goals.

We found that about half of the people who changed their top goal focused on emotions instead of the outcome. Using a master list drew an important parallel between emotional returns and financial returns. Many people who changed their goals settled on outcomes that revolved around emotional security, such as “to feel secure about my finances now” and “to not be a financial burden to my family as I grow older”. While emotions are often seen as anathema to sound financial decisions, our results suggest that there’s a big emotional component to holistically defining financial goals.

If your goals changed, you’re not alone. At Morningstar, we created a worksheet to guide clients through the process of setting financial goals. Advisors can use this printable exercise to nudge clients toward deeper consideration of what goals are most important to them. This can prompt a meaningful discussion around goal setting and help people avoid top-of-mind, but superficial, goals. We also recommend that you read our research report Mining for goals to find out more about the research behind the worksheet.

Behavioural biases, that often creep in during the goal-setting process, surface when we are facing uncertainty — and when it comes to investment decisions, these biases can hurt more than they help. Investors may benefit from having a resource of their own from which to learn the impact of behavioural mistakes on their finances and how to avoid them. We created a checklist you can send to your clients to help them start to incorporate behavioural techniques into their financial decisions.

This checklist is written for investors, so you can offer clients a resource they can peruse on their own time as well as in your virtual check-ins. This way, you can both work together to help clients thoughtfully navigate their financial decisions and empower them to use behavioural techniques on their own when they may need them the most.

Investors are facing quite a few obstacles when it comes to making thoughtful financial decisions. We can’t erase the emotions and biases that come with these unprecedented times, but effective planning and practicing some behavioural techniques can help investors prevent these factors from getting in the way of their long-term financial goals.

This is where advisors can turn to lessons from behavioural science to help keep investors on track. We’ve created a guide and checklist for advisors to explore how to use these behavioural techniques in their practice.

Understanding your financial goals is central to financial planning but identifying goals that truly matter can be tough. Now, more than ever, we must take the time to avoid behavioural biases, establish strong financial goals, and implement behaviours to help meet these goals.

1 – Blanchett 2015; Locke et al. 1990).

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.
+ t: (0)21 201 4645 + e: MIMSouthAfrica@morningstar.com + 5th Floor, 20 Vineyard Road, Claremont, 7708.

You can’t predict but you can prepare

The importance of good saving habits

As we emerge from the stringent lockdown restrictions of the past 100 plus days, many of us are now facing a world that looks quite different from what we were used to merely months ago. For many of us, things have changed drastically, especially financially. With July being “National Savings Month” in South Africa, it is perhaps time to pause and dwell a bit on the topic of savings.

 

Countless individuals have been faced with and/or might still face retrenchment, having to take unpaid leave, drastic salary cuts or the possibility of losing their business. This reality hits home hard. Due to the unforeseen and devastating aftermath of the Covid-19 pandemic, many individuals have been forced to tap into their savings. The current circumstances have made people acutely aware of how important it is to have an emergency fund and/or contingency plan.

 

With this in mind, let’s unpack the famous words of the well-known investor, Howard Marks: “you can’t predict but you can prepare”.

 

Prediction is a fool’s game

The first point to highlight is that trying to predict the market is fool’s game, however, it is human nature to try to find comfort in some sort of prediction of an outcome. This is because humans like to think they know what is going to happen next.

 

Using a very simple mathematical example, the below equation illustrates how the odds are against you when trying to predict an outcome. Firstly, you have to predict the event correctly, and secondly, you have to predict how the market will react as a result of the event. If you don’t get both right you won’t be able to capitalize on the opportunity. Let’s say you are exceptionally good at predicting and you get it right 70% of the time, the odds are still the same as flipping a coin.

 

Probability of predicting the event correctly x Probability of predicting the market’s reaction correctly

= 70% * 70%

= 49% (same odds as flipping a coin)

 

The table below details two examples of recent events that an investor could have predicted accurately, but most people got the second prediction – how the markets will react – wrong.

 

 

As we reflect on the events of the past couple of months, one thing is certain: it was impossible to predict the events that have unfolded this year and the resulted reaction of markets, governments and economies.

 

The only thing we can do is to do our best to prepare for times like these.

 

Preparing for the unknown

In a world filled with randomness and uncertainty a far better strategy than to prepare for the unknown is to focus on the known. What is known is that there are three primary drivers of results in life:

 

1) Your luck (randomness).

2) Your strategy (choices).

3) Your actions (habits).

 

Only two of these three drivers are within your control – your strategy and your actions. By focusing your efforts on your choices and habits, you take ownership of your finances, instead of leaving it up to chance.

 

The best way to prepare for these unknown and unprecedented times is to build up a nest egg. The most obvious way of doing this is by saving and taking advantage of the power of compounding.

 

In the words of Warren Buffett – “Do not save what is left after spending but spend what is left after saving”. Unfortunately, many investors tend to spend first and save what is left. Often these investors also make the mistake of not saving the little that is left, as they believe it won’t make a difference.

 

In January 2020, Victoria Reuvers, managing director of Morningstar Investment Management South Africa wrote an article in which she shows that anyone has the ability to become a millionaire. What it requires are two simple, but not easy, habits – firstly, start and stick to the habit of saving and secondly, be patient. Most investors’ path to becoming a millionaire is not by investing in the next big thing and making a quick buck overnight. For most of us, it is about building good habits and being disciplined when it comes to saving – even if it is just R200 a month.

 

We encourage investors to use July as an opportunity to re-think their budget, savings and spending habits and encourage their children to practice good habits from a young age. Think about a good savings habit like brushing your teeth. Twice a day for two minutes is all it takes, and although it may not feel like a big action at the time, the long-term positive effects are enormous. The problem when you don’t do it is that you only see the damage your poor habits have caused after a long period of time.

 

Some practical ideas to start saving

In South Africa, you can save R36,000 per annum in a tax-free savings account, and a maximum of R500,000 over a lifetime. This is probably the easiest vehicle to ensure you get the benefit of investment returns without the concern of a tax bill at the end of the financial year. Another effortless way to save is to set up a monthly debit order to an investment account. Not only do you then save first and spend after saving, but you also have the option to increase this amount annually and/or make lump sum contributions as well.

 

Other tips to start saving money every month:

  • Assess what you are paying in bank charges and if you are using all the additional services. You can perhaps switch to a cheaper offering.
  • Contact your insurance provider to re-negotiate your monthly premium.
  • Cancel any memberships that you don’t use.
  • To save electricity consider replacing all your lightbulbs in the house with energy-efficient ones and use gas appliances where possible.
  • Reduce discretionary spend: Try to buy clothes, furniture, appliances and other discretionary items only when they go on sale and don’t buy these items on credit.
  • Buying groceries in bulk can greatly reduce your grocery bill.
  • When going on holiday, shop around for special deals on flights and accommodation and search for discount coupons in the area that you are visiting.

These are just a few examples and there are many more ways to save a couple of Rand every month. Don’t ever think that it is too little to have an impact. There is a lot of power in compounding value.

 

Conclusion

In unusual times like these, investors might feel vulnerable and powerless. But it is often during times like these that we should try to form new healthy habits and leave behind bad habits. Let’s try to kick the practice of trying to predict everything and kickstart the habit of saving, even if only in small increments.

Debra Slabber, CFA®

Business Development Manager

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.

Budget 2020

On 26 February 2020, Finance Minister Tito Mboweni delivered the annual budget speech, providing an update on South Africa’s finances. Despite the budget speech highlighting the fragile state of the country’s fiscal position, the finance minister announced some much-needed relief for South African citizens. There were no major tax increases on individuals, while ambitious plans were announced to reduce expenditure over the next three years.

A high-level summary of the key points from the budget speech has been included below:

KEY TAKE OUTS

Revenue and deficits

  • Low growth has led to an R63 billion downward revision to estimates of tax revenue in 2019/2020 relative to the 2019 budget.
  • The consolidated budget deficit is now estimated to be 6.3% for the 2019/20 fiscal year and move lower to 5.7% for the 2022/23 fiscal year, with debt to GDP expected to rise to 72% over this period.

Taking a look at tax

  • There will be above-inflation increases in the personal income tax brackets and rebates (for the first time since 2014) which will provide relief to taxpayers.
  • There will be no changes to the tax-free portion of interest income (R23,800 for under 65’s and R34,500 for over 65’s).
  • The annual limit for investments in tax-free savings accounts will be increased to R36,000 and the lifetime limit will be kept unchanged at R500,000.
  • There will be no change to the corporate income tax or VAT rates, however, the minister announced that the corporate tax system will be restructured over the medium term, with the rate likely to be reduced.
  • The cap on the exemption of foreign remuneration earned by South African tax residents will be increased to R1.25 million from 1 March 2020.
  • In terms of capital gains tax (CGT), the inclusion rate remains at 40%, the annual exclusion remains at R40,000 and the exclusion for the sale of a primary residence remains at R2 million.
  • In terms of transfer duty on property, the purchase amount free of transfer duty increases to R1 million.
  • The deductible monthly medical aid contributions were increased to R319 for the first two members and R215 for each additional dependent.

Expenditure

  • National Treasury announced plans to reduce expenditure by R261 billion over the next three years, including a reduction in the wage bill of national and provincial departments and national public entities of R160 billion.

Levies, duties and charges

  • The fuel levy will be increased by 25c per litre, which will consist of a 16c per litre increase in the general fuel levy and a 9c per litre increase in the RAF levy.
  • Excise duties on alcohol and tobacco will increase by between 4.4% and 7.5%. Government will also introduce a new excise duty on heated tobacco products, which will be at 75% of the cigarette excise rate.

State initiatives

  • Government will move ahead with plans for a sovereign wealth fund, which will initially have a targeted capital amount of R30 billion.
  • The establishment of a state-owned bank will involve the amalgamation of existing state-owned banks, including Postbank, with the aim of lending money to lower-income consumers and small businesses at favourable interest rates and terms.

In closing

Overall, the budget speech was well received by market participants, with both the rand and local bond yields reacting favourably on the day. The budget was largely pro-consumer, with no additional taxes being announced for individuals. In a surprise move, above-inflation increases in the tax brackets for individuals were also announced for the first time since 2014. The business sector will most likely welcome the state’s plans to restructure the corporate tax system over the medium term.

The most ambitious element of the budget speech was no doubt the plan to reduce the public sector wage bill by R160 billion over the next three years. With expenditure on public sector wages currently making up 35% of total expenditure, implementation of this reduction will be key.

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.

Surviving the short term to thrive longer term

The current challenge facing many long-term investors is to simply survive the shorter-term market disappointments to benefit from the return premium offered by growth assets over the longer term.

For many investors, the last five years have been traumatic. Domestic woes and instability in global markets have resulted in muted returns across almost all asset classes.

 

Figure 1: A range of factors have led to disappointing returns

Source: Investec Asset Management.

While global assets have outperformed local assets, this outperformance is mostly due to rand depreciation, as evidenced in Figure 2. Over the five years to the end of October 2019, the rand has depreciated by as much as 7% per annum against the US dollar, thereby making up the bulk of the rand return for global cash and bonds and more than half the return for global equities.

 

Figure 2: Five-year annualised returns in rands to 31 October 2019

Market returns have proven a significant challenge for people drawing an income

A lack of retirement savings and depressed investment markets have left many pensioners anxious about the future. Jaco van Tonder, Advisor Services Director, has explored the challenges facing retirees as part of Investec Asset Management’s in-house research study into “How investors should approach living annuities”.1

Jaco makes the point that even though the principle of “beating inflation requires exposure to equities” is widely accepted by investment professionals, it is easy to overlook this principle in situations where an investment portfolio is required to produce an income. Jaco also makes two conclusions that are relevant to this article:

  1. Living annuities require meaningful equity exposures to enable the annuity’s income levels to keep pace with inflation.
  2. Fixed income portfolios are unable, on their own, to produce the returns required to keep pace with inflation.


Investing in the wrong asset class is costly in the long term

Despondent investors have increasingly sought refuge in fixed income investments, thereby potentially compromising their long-term investment goals. This behavior is even true for conservative investors who had previously invested in multi-asset low equity funds (i.e. lower risk funds that target inflation beating returns over rolling three-plus years), such as the Investec Cautious Managed Fund.

For long-term investors, however, investing in the wrong asset class can prove costly. The South African Savings Institute (SASI) makes the point that while in the short-term cash and bonds may be somewhat safer, in the longer term they provide less protection against inflation and therefore are unlikely to maintain real buying power.

 

1 – A new approach to living annuities: https://www.investecassetmanagement.com/south-africa/professional-investor/en-za/insight/living-annuity-an-active-solution/.

Furthermore, tax considerations generally accentuate this outcome. SASI’s analysis suggests that over time, the four domestic asset classes are likely to produce the following real (after inflation) returns in the long run:2

• Cash: 0 to 1%

• Bonds: 1 to 3%

• Property: 2 to 4%

• Equities: 7 to 9%

It is also important to note that with inflation well within the target range and developed market interest rates at all-time lows, interest rates in South Africa are likely to trend downwards. The attractive real returns offered by money market and other flexible fixed income investments are therefore likely to come under pressure as a result. At the same time, we are now far more optimistic on the prospects for growth assets to deliver inflation-beating returns in the future.

 

Targeting consistent real returns to conservatively grow your savings

We therefore continue to argue that conservative investors should reconsider the important role that multi-asset low equity funds can play in their portfolio. These funds offer a bias to income-generating assets, while maintaining a growth element.

The Investec Cautious Managed Fund, for example, is suitable for conservative investors saving for retirement and for retirees drawing an income from a living annuity. The fund is well-positioned to meet these needs, thanks to its broad investment opportunity set that allows for investment in assets that offer growth and income, and a strong emphasis on capital preservation. As a result, the Investec Cautious Managed Fund has delivered a positive real return over rolling three-year periods 80% of the time, as shown in Figure 3.

 

Figure 3: Growing investor capital in real terms

A key strength of the fund is its ability to exploit the changing investment opportunity set. Historically, multi-asset funds have looked to South African equities as the primary driver of real returns and offshore bonds as the uncorrelated defensive asset. However, we believe that offshore equities are now the best opportunity for growth, with South African bonds offering attractive risk-adjusted returns, as well as helping to counterbalance risk in the portfolio.

 

This view is reflected in the next two charts. Figure 4 shows the changing asset allocation of the Investec Cautious Managed Fund over time, while Figure 5 depicts the Quality capability’s range of expected returns over the next five years from the different assets held in our Quality portfolios, including the Investec Cautious Managed Fund.

 

Figure 4: Investec Cautious Managed Fund asset allocation since 2006

Figure 5: Range of expected annualised returns for current Investec Cautious Managed Fund holdings (in rands)

In conclusion

In today’s uncertain investment environment, asset allocation and stock selection are key. Conservative investors should consider entrusting a portion of their investments to the experienced, well-resourced and globally integrated portfolio management team who manages the Investec Cautious Managed Fund. To quote, Duane Cable, Investec Cautious Managed Fund Portfolio Manager: “In the volatile world in which we find ourselves, it has become increasingly apparent that one needs to have a global perspective to navigate the choppy waters of investment markets”.

Important information

All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The TER of the Investec Cautious Managed Fund (A) class is 1.73%. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is an authorised financial services provider. Issued, December 2019.

Graphic design and color swatches and pens on a desk. Architectu

Prescribed Assets

What are ASISA’s views on prescription of assets and why?

When the term “prescribed assets” is used, it is understood to refer to Government forcing the savings industry to buy Government stock as well as bonds issued by State Owned Enterprises (SOEs) on behalf of investors like retirement funds. This concept was first introduced by the previous Apartheid government and has been raised periodically over the years by various political parties.

It did not work when introduced by the Apartheid government and ASISA and its members maintain that it would have negative effects on the country should it be introduced now.

The savings and investment industry, as represented by ASISA, has engaged extensively with various relevant parties on the potential impact of “prescribed assets”, including directly with Government Ministers tasked with infrastructure development, via Business Unity South Africa (BUSA) into the National Economic Development and Labour Council (Nedlac), and via the CEO initiative.

The Government under President Ramaphosa has been very collaborative as evidenced by the various engagements like the Jobs Summit, Investment Summit and the ongoing engagements with the CEO initiative. If “prescribed assets” are again tabled for discussion by Government, we believe engagements with our industry will be equally constructive.

ASISA is empowered by a mandate from members that manage some R6.2 trillion of the nation’s savings and investments and is therefore recognised as a significant and relevant partner around Government’s negotiation table. We regularly engage on a number of issues regarding policy, regulatory reform and other issues of national priority such as economic transformation and inclusion.

Why do we oppose “prescribed assets”?

  • The concept of “prescribed assets” would force the savings and investment industry to deploy the savings of ordinary South Africans into entities that have over the recent past been mired in State Capture and lack of delivery. As custodians of these savings we have to oppose this.
  • Asset managers are not asset owners. The bulk of the assets that could be prescribed are owned by retirement fund members. It also needs to be noted that roughly half of these assets are held by the GEPF and are therefore owned by public servants. As the owners of these assets, ordinary South Africans elect and appoint trustees to make asset allocation decisions that are in their best interest. Prescription would jeopardise this fiduciary duty.
  • Prescription of assets interferes with the capital allocation function of the capital markets, which should always be objective and driven by performance. Forcing the market to invest in low yielding and/or high risk projects could have two direct consequences:
     – The incentive for these projects to compete would be removed as funding would no longer be incentivised by performance.

– Given that capital is a finite resource, deserving projects could be deprived of funding. These projects that would otherwise have driven growth and created sustainable employment would now not happen anymore.

  • Prescription would have a negative impact on the country’s credit rating. If South Africa loses its investment grade rating, foreign investors, many of whom are pension funds, would be forced to withdraw their money from South Africa. This is something the country can ill afford.

Working with Government on infrastructure finance

ASISA has always maintained that the problem is not the lack of willingness of capital markets to invest, but rather the absence of viable projects. We are engaging with Government to address this with urgency.

ASISA and its members believe that many of our country’s challenges can be overcome through effective public private partnerships (PPPs).

ASISA was therefore represented by several of its Board members as well as senior policy advisers at President Cyril Ramaphosa’s Investment Conference last year, which took place under the theme “Accelerating Growth by Building Partnerships”.

ASISA is actively involved in working with Government on infrastructure finance for water, energy and student accommodation. We are also looking at collaborative delivery mechanisms with Government and the Development Bank of Southern Africa (DBSA) for programmatic financing solutions.

ASISA members have already deployed more than R1.3 trillion in support of Government, Local Authorities and State Owned Companies.

In addition, our industry has made direct investments of R200 billion into the following projects:

  • Renewable energy
  • Township development
  • Affordable housing
  • Urban regeneration
  • Student accommodation
  • Water
  • Roads
  • Agriculture (emerging farmers)

Building Cityscape

How would a downgrade impact the South African bond market?

The short answer to the question above is that a downgrade would lead to it being more expensive for the South African government to borrow money.

Let’s first look at what it means to be downgraded. Think of it as a credit score from your bank manager – the less likely you are to default on your debt repayment, the better your score will be, whereas a weak score would indicate that you are more likely to default, and not be able to repay your debt.

When you have a bad credit score and you are seen as someone that could potentially not repay a loan, the establishment extending the credit to you assumes more risk in lending the money to you (as opposed to someone with a good credit score). Therefore, the credit provider will charge you a more expensive rate in order to be compensated for the increased level of risk it assumes in lending you the money. In the same manner, South Africa is rated on its ability to repay its debt and charged more when it has a bad credit rating.

 

So, what would the implications of a downgrade be for South Africa?

The rand could weaken against the US dollar due to foreigners selling local bonds. A sub-investment grade rating by all three major rating agencies would result in South African government bonds being removed from some major world bond indices such as the World Government Bond Index (WGBI). This could translate to a forced selling of South African bonds by international investors that are mandated to only hold investment-grade credit. In other words, certain investors would have to sell S.A. bonds as they won’t be allowed to hold such an investment.

Over the past decade, foreigners have bought a lot of government bonds and at the peak, they owned close to 40% of our bond market. However, of late, they have been selling our bonds and this number is now closer to 30%, which is still meaningful.

Whilst market pricing would suggest that these risks are priced into S.A. bonds (given that they are offering investors a real yield of close to 4%), it is possible that we could see yields creeping higher on the day of the downgrade, along with a weaker rand. Remember, if bond yields rise, it results in capital losses for bond holders. With that said, rising yields could also create buying opportunities for investors. Times of panic and stress often present golden opportunities to enhance returns if one can price risk appropriately.

 

If history is the best teacher, what have we learnt?

Like South Africa, Brazil has also suffered from political uncertainty over the last couple of years. Midway into 2015 Standard & Poor’s (S&P) changed the status of Brazil’s sovereign credit rating outlook to negative. The change in the outlook (not an actual downgrade) led to the demand for the government’s ten-year bonds dropping. This is similar to the conditions that South Africa is currently faced with.

Upon the news of Brazil’s outlook change, yields went from 12% to exceeding 16%. The currency followed suit and depreciated by roughly the same amount against the US dollar in approximately the same period – all without the country being downgraded.

Expectations were paved and the market priced in (the more than likely possibility of) a downgrade. In September 2015, as predicted, Brazil took the plunge from investment grade to junk status (a move from BBB- to BB+ in Standard & Poor terms).

It is interesting to note that both the currency and the yields started to strengthen/contract as if the market had predicted the worst-case scenario, priced the risk accordingly, and then pro-actively managed this risk before it even came to fruition.

It would seem, at the moment, that the global market has taken the same stance with South Africa and is virtually pricing in the worst-case scenario (before the actual event has occurred). As illustrated in the graph below, South Africa is currently one of the few countries globally to offer healthy real yields (this is after taking inflation into account) but is still required to pay more than countries such as Brazil and Mexico, both of which are already rated at sub investment grade.

Despite all the noise and concern the possibility of a downgrade has created, Morningstar continues to monitor developments and follow a rigorous valuation driven approach with the aim of building well-diversified portfolios that will meet end investors investment goals over reasonable time frames.

In an environment where inflation is around 4.5% and S.A. government bonds are yielding close to 8.8%, we believe the real yield of over 4% is an attractive investment. In addition to this, government bonds provide portfolio protection against a strengthening rand. While the rand has weakened dramatically over the past few months, we believe it is now looking slightly oversold.

Bringing this together, we believe the market conditions are challenging although not incomprehensible. Achieving positive portfolio outcomes continues to be our long-term focus, which is driven by a willingness to be different from others and in applying a disciplined investment approach.

Eugene Visagie

Portfolio Specialist, 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.