Leading investment managers are “cautiously optimistic” about the year ahead, but most are betting that offshore equities will be the asset class to deliver good returns for you in 2011.
Despite the threat of losing the huge amounts of foreign investment that flowed into the local bond and equity markets, and with the rand at what is widely regarded as inflated levels relative to other major currencies, the mood among investment managers for the year ahead is cautiously optimistic, Paul Stewart, the managing director of Plexus, says.
But while managers say that, among local asset classes, equities are still likely to be your best bet for returns, many managers are taking their offshore allocations to their highest levels and recommend that, if you haven’t yet diversified offshore, you do so now.
Peter Brooke, the head of macro strategy investments at Old Mutual Investment Group South Africa (Omigsa), says a strong chance that the rand will depreciate, the logic of diversification, and attractive relative valuations are all good reasons for you to increase your international equity exposure.
He forecasts a return from international equities of 6.5 percent above inflation over the next five years and believes this will be the best-performing asset class in real terms over five years.
Brooke says Japan and Africa offer good opportunities. Japan has under-performed for years and is trading at levels last seen 30 years ago, and Africa has underdeveloped equity markets but good growth prospects and a large resource base.
Brooke says the government’s decision late last year to ease exchange controls was well timed, and he has used the strong rand to increase the offshore exposure of Omigsa’s actively managed asset allocation funds.
Michael Moyle, the head of real return at Prudential Portfolio Managers, says Prudential favours developed equity markets over South African equities in the medium to longer term.
He says that although most overseas markets have recovered strongly since they bottomed in March 2009, the valuations of global shares are still attractive in many markets because the recovery was off a low base.
Coronation is also of the view that global equities offer more value than local ones, and has taken advantage of the relaxation of foreign investment limits on retirement fund portfolios to increase its offshore exposure in these to close to the new limit of 25 percent.
Stanlib’s head of balanced funds, Paul Swanson, says Stanlib reduced its local equity exposure in the fourth quarter of last year. In the third quarter, it switched its offshore exposure to the maximum global equity weighting.
Swanson says in foreign markets Stanlib prefers technology stocks and emerging market shares, and it is underweight in financial shares.
Absa Asset Management says in its latest Private Clients newsletter that the global economy is likely to show positive growth but at a slightly slower pace than last year as a result of slower expansion by developing economies.
It says Barclays Capital expects real domestic product growth globally to be 4.2 percent this year (from an estimated 4.8 percent last year), with emerging markets delivering 6.4 percent (down from an expected 7.7 percent last year) and developed countries logging 2.5 percent (from 2.6 percent last year).
Investec’s London team expects global growth to continue to pick up in 2011 on the back of the growth of emerging markets.
Philip Saunders and Max King of Investec’s Global Multi-Asset Team say the pressure on governments to cut their debt will increase, and a muted appetite for bonds in the United States and United Kingdom will be positive for equities and negative for government bonds.
Tristan Hanson, Ashburton’s head of asset allocation, says Ashburton has its bets on equities as the top performer among offshore asset classes. He says valuations do not look expensive, especially relative to bonds and cash, profit margins have risen appreciably and earnings expectations look achievable.
He says corporate balance sheets are in excellent health with high levels of liquid assets and low levels of gearing, while corporate borrowing rates remain low.
Hanson expects positive company-level news in the form of dividend increases, share buybacks and further merger and acquisition activity throughout the year as business confidence grows.
Despite being most upbeat about offshore equities, fund managers acknowledge there are big risks.
Quinton Ivan, an equity analyst at Coronation, says in Coronation’s latest newsletter to investors that despite the rally in world equity markets towards the end of last year, the global economic recovery remains fragile as reflected by weak housing data and high unemployment in the US and sovereign debt concerns in Europe.
In addition, he says, “the sheer quantum of the monetary and fiscal stimulus employed to support growth has moved the world economy into unchartered territory. We are possibly living through the greatest financial experiment the world has known: if the stimulus is withdrawn prematurely, the world economy risks slipping back into recession; if it’s in place for too long, the effect will be higher inflation, which will compromise future economic growth.”
Stanlib economist Kevin Lings warns that while the US’s gross domestic product and consumer spending are growing, the US is not yet out of the woods.
He says the housing market, the backbone of the US consumer, is still in difficulty. Foreclosures continue to increase, house prices continue to decline and there is still a housing glut, with 14 million vacant homes.
The second major risk facing the US is its unemployment levels, Lings says. He says the recovery of jobs is taking longer with each recession in the US, and there has been a structural decline in manufacturing with a consequent loss of jobs.
Most asset managers also point to debt problems in euro-zone countries such as Portugal, Spain and Greece.
Investec director Jeremy Gardiner says the euro zone will probably hang together but warns of shocks to the global financial system as a result of problems in the zone.
However, in Investec’s London office, Saunders and King say the break-up of the euro zone is inevitable because peripheral European countries have lost their competitiveness relative to northern Europe, which will make it impossible for them to reduce their government debt.
Saunders and King say the break-up of the euro zone (meaning that each country will revert to its own currency and economic system) could provide a welcome stimulus to the global economy and markets. The chaos and crisis that would come with this could provide opportunities to add to equity exposure, they say.
Gardiner says another risk to the recovery around the world is China’s tenuous control of its red-hot economy.
Better-than-expected growth numbers coming out of China show that the country has not yet succeeded in slowing things down by raising interest rates and cutting back on bank lending.
The risk is that the Chinese government eventually overdoes it and slows things down dramatically, which would have a massive impact on global growth, Gardiner says.
He says investors are likely to prefer equities to cash and bonds and, as a result, equities should produce solid if unspectacular returns this year.
W(H)ITHER THE RAND?
The value of the rand is a major factor in determining what you earn from offshore investments, and its strengthening against other major currencies since late 2008 has negatively affected your returns.
After being the world’s third-strongest major currency in 2010, the rand weakened eight percent last month.
Stanlib economist Kevin Lings says the direction the rand will take is very difficult to call because it is a highly traded currency that tends to weaken when uncertainty rises. While the rand fell strongly last month, the Egyptian currency declined only one percent despite the political troubles there.
Omigsa’s Peter Brooke says the rand’s real value is expensive by historic measures. He says big global investment themes – the emerging market theme, the strong demand for commodities and relatively high local interest rates – will continue to support the rand this year, but these themes are weakening.
He says gradual interest rate hikes elsewhere, a possible slowdown in emerging-market growth (particularly China) and an upside surprise in United States growth could all mean bad news for the rand.
Absa says the rand’s fortunes will remain tied to the appetite foreigners have for local bonds.
Coronation’s view is that our currency is overvalued and will weaken because the country is uncompetitive.
OUTLOOK FOR GLOBAL BONDS
The highly stimulating monetary and fiscal policies around the world are expected to bring some risks of inflation, Absa Asset Management says.
Emerging markets are generally expected to tighten their monetary policies in response to these risks, while developed markets are likely to maintain loose monetary policies for the rest of the year due to weak growth in these countries.
Paul Stewart from Plexus suggests that countries such as Australia and Canada, which avoided the credit crisis excesses, may even implement small interest rate increases by year end.
Investec’s Philip Saunders and Max King say the bonds of debt-stressed European countries should be avoided and, as the flow of money into government bonds reverses, these bonds are likely to deliver negative returns.
Developed-market government bonds look risky and susceptible to rising yields, Stewart says. Best-quality corporate bonds and mid-duration government bonds in the United States, Germany and the United Kingdom are probably the best bet, he says.
Ashburton fund manager Tristan Hanson is banking on emerging market and corporate bonds doing better than developed market government bonds. He says US and UK government bonds with long terms to maturity (30 years) are also likely to perform better than other government bonds if fears over global growth resurface.