Unit trusts deliver, but it’s ‘time to be cautious’


Investors in a number of unit trust sectors have earned great returns over the one- and three-year periods to the end of September, despite all the uncertainty around the world and the economically damaging events in South Africa.

Alan Ehret, director of business development at Stanlib Retail, says that despite the uncertainty surrounding the United States reducing its budget deficit next year (referred to as the “US fiscal cliff”), the ongoing European debt crisis, slowing growth in China, and, closer to home, the Marikana disaster and wildcat strikes, investors have been rewarded for investing in growth assets.

For example, over the 12 months to the end of the third quarter, which ended on September 30, investors in domestic real estate funds enjoyed average returns of 32.71 percent, while investors in general equity funds, on average, earned 21.56 percent.

Foreign equity general funds returned 18.74 percent, on average, and bond funds returns have averaged 15.79 percent.

“Most categories look good when comparing third- and second-quarter returns,” Craig Pheiffer, general manager at Absa Investments: Private Client Asset Management, says. “In uncertain times, we should be thankful for strong performance, but we could be approaching a critical period in the coming months, so it’s best not to get carried away.”

Pheiffer says with interest rates at historical lows as a result of central bank policies in all the major developed economies, investors have been looking for alternatives to cash.

Equities have benefited as the only viable investment alternative, he says.

This has driven local and international share markets higher, while economic growth has been slower and growth in company profits has declined substantially.

“This is one reason for the cautious stance taken by some analysts, and it’s the reason we are cautious on equity markets now.”

Ehret says foreigners have continued to surprise the markets by being strong buyers of local bonds for the past few years, due to the appealing yields that South Africa offers relative to offshore markets.

Last year, foreigners were net buyers of R50 billion of bonds, and they have already bought over R84 billion so far this year, Ehret says.

They have soaked up most of the new issuance of bonds, forcing yields down and prices up, he says.

Neville Chester, senior portfolio manager at Coronation, says although the weaker rand caused foreigners to sell off local bonds, this was counter-balanced by South Africa’s inclusion in the Citigroup World Government Bond index, which saw a lot of index-tracking money flow into local bonds despite the deteriorating fundamentals.

Ehret says there is a high correlation between bonds and the listed property market, and foreign buying has also been extremely beneficial for the listed property sector, which has returned over 30 percent already for the year since January.

Equity markets have been supported by continued bank stimulation, both locally and offshore.

Buoyant offshore markets have led the way, and local companies, with the exception of the mining houses, continue to deliver good earnings on the back of good profit margins and strong, stable balance sheets, Ehret says.

Both Ehret and Chester say the local equity market has been supported by the weakness of the rand. The rand weakened from R8.16 to R8.31 to the US dollar over the past quarter.

Chester says that because many companies listed on the JSE do business offshore or sell into global markets, weakness in the rand supports their share prices.

In US dollars, the FTSE/JSE All Share Index (Alsi) is up only eight percent for the year to this week, while in rands the Alsi’s return for the same period is 18 percent, Chester says.

Despite the recent good returns, Pheiffer points out that the returns for the year ended September 30 are in the early teens, which is a far cry from the heady 20 to 30 percent some investors had come to expect.

John Kinsley, managing director of Prudential Unit Trusts, says you shouldn’t consider returns from a single year only, but rather look at a five-, 10-, 15- or even 20-year horizon. He says if you look at the five-year returns ended September 30, you will see that they are more muted.

YOU COULD LOSE MONEY BY FOLLOWING THE HERD

You could be at risk of losing some of your capital if you invest in expensive shares that are performing well, such as those of local retail companies, Gavin Wood, chief investment officer of Kagiso Asset Management, warns.

Local industrial shares are up more than 250 percent from their troughs during the 2008 financial crisis, and more than 70-percent up on their peaks reached before the crisis, Wood says. In contrast, resources shares are down 20 percent from where they were before the start of the crisis.

The reason industrial shares are so buoyant is that more foreign investors are participating in our market, Wood says. Investors in extremely troubled economies in the northern hemisphere see a dearth of opportunities in their own markets. The remarkably good financial results of many South African consumer-oriented industrial shares have underpinned foreign flows into these shares, he says.

Wood says well over 50 percent of South Africa’s retailers, such as Massmart, Truworths, Shoprite and Clicks, are owned by foreigners.

The actions of these foreign investors, who seem to be very focused on the short term and appear unconcerned about valuations (price relative to the earnings and other business measures), are driving share prices in our market to extreme levels, Wood says.

This results in a self-reinforcing loop in that further capital is attracted to these shares owing to their good performance, he says.

While prices of industrial shares are being driven to extreme levels, earnings are also very high, and these businesses face economic risks, such as increasing competition and, eventually, rising interest rates.

South Africa’s economic outlook is deteriorating and unsecured lending has ballooned, resulting in unsustainable consumer spending, Wood says.

Consumers are effectively spending their future salaries, inflating the profits of retailers and car dealerships, he says. At some stage, this situation will snap and reverse, he says.

Meanwhile, local resources shares are at their lowest valuations in over a decade, Andrew Dittberner, senior investment manager at Cannon Asset Managers, says.

The weighting of resources shares in the FTSE/JSE All Share Index has fallen from 47.3 percent to 31.7 percent over the past five years, he says.

“This spectacular fall from grace has largely gone unnoticed by investors, who have fallen out of love with the sector, and this could present a really interesting investment opportunity,” he says.

The FTSE/JSE SA Resources Index’s price-to-earnings ratio (p:e) has fallen from 16.5 to 9.5 over the past year, despite the fact that it has been the best-performing sector in terms of real (after-inflation) earnings growth.

Over the five years to August 2012, resources shares’ earnings (profits) have grown by 112 percent ahead of inflation, Dittberner says.

Dittberner says although the short-term outlook for resources may be clouded by the current labour unrest, the struggles in the developed world and concerns over a slow-down in Chinese economic growth, Cannon believes some opportunities are opening up for investors in this sector.

However, stock selection and paying the right price, as always, remain key components of investment success, Dittberner says.

GLOBAL IT AND DEFENSIVE SHARES ‘VERY EXPENSIVE’

A price bubble appears to be developing in the global information technology (IT) sector, led by Apple, while defensive sectors – those that do well regardless of the economy, such as consumer goods and health care – are also looking very expensive, Craig Chambers, managing director of Dibanisa Fund Managers, says.

Meanwhile, financial, oil and gas, and telecommunications companies in developed markets are attractively priced, he says.

Offshore equities have been particularly popular with South African investors this year, given the attractive valuations (share prices relative to earnings) in certain regions, the growth potential in others, and the benefits of diversifying offshore, Chambers says.

The record low global interest rates have made fixed-interest assets unpopular. As a result, share prices in certain sectors have been driven high, and investors should be cautious about “following the herd” when choosing where to invest, Chambers says.

He says the global IT sector is very overvalued, with a price-to-earnings ratio (p:e) of 20.3 and a dividend yield of only 2.45 percent.

Chambers says it appears another tech bubble similar to that of the late 1990s is developing. “Apple’s market capitalisation has skyrocketed far beyond the company’s actual economic impact – at R5.2 trillion, its market cap is larger than the gross domestic product of Switzerland and it is overly influencing traditional market-cap indices.

“Consumer goods is another sector being overvalued due to investors’ current herd mentality towards defensive stocks. The sector is on a p:e of 17.3, while the dividend yield is only 3.06 percent,” Chambers says.

The Dibanisa FTSE RAFI All World Index Fund tracks an index that differs from the market-weighted FTSE All World 3000 Index, weighting shares according to their valuations. It measures companies’ cash flow, book equity value, total sales and gross dividends.

As a result of tracking this index, the Dibanisa fund has much less exposure to the global sectors that are expensive, Chambers says.

On the other hand, he says, financial sector shares are looking attractive thanks to a p:e of 13.32 and a dividend yield of 4.15 percent, among other measures. This has resulted in the Dibanisa fund having greater exposure to the sector – 25.28 percent versus the FTSE All World Index at 20.73 percent.

DEFINITIONS

* Price-to-earnings ratio (p:e): shows the price of a share relative to what the company has or will earn in profits. A p:e for a market sector is based on the p:e’s of all the shares in that sector. These p:e’s can be compared to long-term average p:e’s to determine whether the prices of the shares in the sector are too high.

* Dividend yield: a ratio that shows how much a company pays out in dividends each year relative to its share price.

Unit trust sector graphs


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