You, your financial adviser and your product provider are going to have to make some tough decisions if you want to make the best of thinner investment returns over the next few years.
The next 10 years will be more unpredictable and returns will be lower than the last 10 years.
This was the view of economists and asset managers at two presentations this week – one by financial services company MMI and the other by Coronation Fund Managers.
Karl Leinberger, the chief investment officer at Coronation, says one thing you can be sure of is that “the future will not look like the past”. You and your financial adviser will have to take care that the pressures of a low-return and changing economic environment do not result in incorrect decisions, he says.
It is even more crucial in a low-return and uncertain economic environment that people who depend on their investments for an income make judicious decisions on how much they draw down; if they withdraw too much, they will deplete their capital, he says.
“Don’t make the mistake of extrapolating the one-way upward trend of the past seven years,” he says.
Leinberger says the golden period of the past 15 years for South African equities, which was driven by commodities, is over. It is likely that the economy will deteriorate further, resulting in higher inflation and a weaker rand.
While it has always been a good idea to have offshore investments, now more than ever you will need a diversified portfolio with appropriate offshore investments (rand or foreign currency-denominated or rand-hedge local companies that earn their profits offshore) to generate reasonable returns, he says.
But, Leinberger says, the news is not all bad. The current uncertainty has created areas where there is a “disconnection” between the values of some companies and the prices of their shares, which can be exploited. Asset managers need to look for ways to generate long-term sound returns, even if it means sacrificing short-term performance, he says.
Herman van Papendorp, the head of macro research and asset allocation at MMI, says investors who expect history to repeat itself will be disappointed. He looked at two examples.
1. JSE’s ‘new normal’
There is a “new normal” on the JSE, with price-to-earnings (PE) ratios more in line with international norms. This does not mean that JSE-listed shares have become overvalued.
Historically, the average PE of the FTSE/JSE All Share Index has been 12. This means if you bought a share, you could expect it to take 12 years to recover your money. Today, the PE is 17.5. Van Papendorp says it is likely that, in future, the JSE will have an average PE closer to its current value, because the profile and value of the companies listed on the exchange have changed.
Only a few years ago, resource companies made up 40 percent of the total market capitalisation of the JSE. Today, these shares comprise less than 10 percent of the market value of the JSE, while companies that earn most of their revenue offshore, such as Naspers and Richemont, account for more than 40 percent of the JSE’s value.
Van Papendorp says the current PE of 17.5 is in line with the historical PE of 17 of the S&P World Index. He says that the higher valuation has also been caused by foreign investors investing in South Africa and pushing up share prices. They currently own about 40 percent of the listed shares.
He says foreign investors looking for emerging market destinations prefer South Africa to countries such as Russia, where corporate governance of companies is weak or non-existent. Foreign investors are prepared to pay for the quality created by the high level of corporate governance in this country.
2. Rand to remain weak
The rand will not bounce back: don’t expect a repeat of what happened in 2001 and 2008, when it recovered all its losses.
“We are not in the same boat this time; then, we were on the back of the greatest super-cycle of commodities, driven by China,” Van Papendorp says.
The current value of the rand and local interest rates will also be affected by the United States Federal Reserve increasing interest rates. When this happens, global capital will flow back to the US, further weakening the rand.
Both Van Papendorp and Leinberger agree that you need to remain invested offshore, mainly in equities.
Although equities seem expensive, you need to compare the returns from this asset class with the poor returns you would receive if you invested in bonds, whose yields are at all-time lows, they say.
SEVEN VITAL INVESTMENT CALLS
South African investment managers have to make seven big investment calls, of which they will need to get at least four right to earn sound returns in the years ahead, Karl Leinberger, the chief investment officer of Coronation Fund Managers, says. The calls are:
1. Whether to buy or sell commodities. The outlook for commodities is poor because of over-supply, the decline in demand from China and the threat posed by renewable energy. The slump could persist for some time, but demand, and hence prices, will increase |at some point.
2. Whether deep-level platinum and gold mines have value or are a value trap.
3. Whether to buy or sell rand-hedge stocks listed on the JSE.
4. Whether China will have a hard or a soft landing as it moves from an infrastructure-led economy to a consumer-based one.
5. The future of platinum. The move to electric cars will remove the need for catalytic converters, which have sustained platinum prices.
6. Whether to buy the currently cheap shares of producers such as steel manufacturer ArcelorMittal, aluminium producer Hulamin and chemicals producer AECI, which may recover at a future date.
7. Getting the big stocks right. This includes Naspers, Richemont, BHP Billiton and SABMiller, which can all be affected by the global economy and uncertainty.