Unit trust investors may be surprised to find that many funds again delivered strong returns in the first quarter of this year, and the good returns of the past two quarters have contributed to many unit trust sectors producing healthy returns over one year and three years.
The strong returns appear to run counter to the warnings that asset managers have been issuing since the global recession in 2009 that you should expect a “new normal” of lower returns instead of the double-digit returns that characterised the decade to 2007.
But asset managers say the good returns are just another rally, and you need a reality check if you think that you will continue to enjoy such strong performance.
They point out that the returns to the end of March include those made during some particularly favourable periods.
And they continue to favour offshore equities over local ones, despite stronger returns from the local market.
John Biccard, portfolio manager of the Investec Value Fund, describes the recent rally as a “risk on” rally – when investors develop an appetite for risky assets, such as equities, based on positive market or economic developments.
The rally has been prompted by the European Central Bank’s printing of one trillion euros, which has reduced systemic risk by underwriting Europe’s banks, Biccard says.
Like the rallies of 2010 and 2011, this one will “peter out” once the reality sets in again that meaningful economic growth is not possible against the background of the ongoing reduction in debt levels (deleveraging) in both the private and the government sectors following 30 years of excess credit, Biccard says.
David Knee, head of fixed income and tactical asset allocation at Prudential, says that, three years into the recovery from the post-credit crisis market low, the debris from the crisis is evident wherever you look: zero cash rates, stagnant bank lending, large government deficits, high unemployment rates and sluggish economic activity in asset markets.
The increased volatility in global financial markets that followed the 2008 credit crisis has resulted in investors swinging between panic and euphoria, Knee says.
He cautions against extrapolating too much from the good returns that local unit trusts have delivered. Domestic fund returns over three years reflect a particularly “sweet spot”, because the local market has risen by about 80 percent since the FTSE/JSE All Share index (Alsi) reached its low of about 18 000 in March 2009, while local bonds have returned close to 35 percent, he says.
Over the same period, United States equities have more than doubled in US dollars but risen only 50 percent in rand terms, reflecting the cheapness of the rand immediately after the financial crisis and its subsequent appreciation, Knee says.
Andrew Coultas, equity analyst for Foord Asset Management, says some of the headwinds faced by companies are lower world economic growth, financial turmoil in Europe and rising commodity prices. This is not to say that equities are a poor investment, he says. Rather, it is apparent that not all shares will deliver similar returns, because the rising tide is not lifting all ships, he says.
In the future, there will be clear winners and losers, and stock-picking – successfully picking the winners while avoiding the losers – will be the strategy that delivers the best returns, Coultas says.
Dane Schrauwen, fund manager at Foord Asset Management, says although all the ingredients for a recovery are present in the US, as long as there is uncertainty about Europe’s debt crisis and growth in China, companies will retain cash, preventing a strong global recovery.
The uncertainty in Europe is likely to continue for the next 12 to 18 months, and as long as there are no policy errors leading to a banking crisis in Europe, fund managers will find opportunities, he says.
Despite the current uncertainty, Foord is of the view that equities continue to offer the best returns, both locally and internationally, over the medium and long term, but selecting the correct companies to invest in remains extremely important, Schrauwen says.
Knee says investing on the basis of forecasting the nature of an economic recovery this year or beyond is little better than playing roulette.
Prudential prefers to back the odds that have already been priced into the valuations of the different asset classes rather than to guess the path of growth, inflation or interest rates, Knee says. The valuations suggest that long-term investors will take a substantial risk if they are underweight in equities, he says.
One measure of valuations is the price-to-earnings ratio (P/E), which indicates how cheap or expensive a share is relative to the profits the company is expected to make. This can also be applied to a market or market sector.
Local equity valuations have risen from a P/E of seven at the Alsi’s low in 2009 to a current rating of 12, which is close to the market’s long-term average, Knee says.
Substantial interest by foreign investors in local shares has contributed to the re-rating of equities and has also boosted bonds, he says.
Prospective returns from local equities over the medium term are still likely to be in the low double digits, and this makes for a compelling case to invest when compared with the 5.5 percent a year currently offered by cash and 7.6 percent from 10-year government bonds, Knee says.
The attractive valuations of equities offer a substantial buffer against the possibility of underperforming income-producing asset classes, even in the event of rising short-term interest rates, Knee says.
Developed market equity valuations offer an exaggerated version of local market valuations, he says. In developed markets, and in some emerging markets, equities are already priced for a full-blown recession, Knee says.
Should these shares return to anything like fair value, investments in these markets could double in value in rand terms over five years, although recent experience suggests this is likely to be delivered in a very lumpy fashion, he says.
Allan Gray continues to caution investors about the level of the local stock market and their expectations of after-inflation equity returns.
Mahesh Cooper, director at Allan Gray, writes in Allan Gray’s latest Quarterly Commentary that Allan Gray and its offshore sister company, Orbis, are still finding better value offshore. This is not surprising given that, over the past 20 years to the end of February, the local stock market has, in rand terms, been very strong relative to the Morgan Stanley Capital World index (MSCI World), he says. A sum of R100 invested in the Alsi in February 1992 would have been worth R1 669 in February this year, while R100 invested in the MSCI World would have been worth R1 018; R100 invested in a US bank deposit would have been worth R896, Cooper says.
Allan Gray’s Balanced and Stable funds continue to have below-average net exposure to South African shares, he says.
What happened this past quarter
Over three months to the end of March:
Over one year to the end of March:
Over three years |to the end of March:
(SOURCE: PROFILEDATA & PLEXCROWN RATINGS)