Slow economic growth and the expectation that markets will deliver lower returns are bad news for investors.
The latest forecasts from the International Monetary Fund (IMF) show that the South African economy is struggling to keep up with even pedestrian global growth, Stanlib chief economist Kevin Lings told the recent Liberty Corporate Employee Benefits Symposium.
The IMF this month forecast that the South African economy will grow by just 0.1 percent in 2016 and by 0.8 percent in 2017, whereas global growth is forecast at 3.1 percent in 2016 and 3.4 percent in 2017.
Where do investors find good returns in this environment? At the symposium, a panel of fund managers agreed that growth and returns are hard to find, but opportunities do exist.
Andrew Lapping, the chief investment officer at Allan Gray, said that, in an environment where prices are higher than they have been, returns will be lower.
Neville Chester, a portfolio manager at Coronation Fund Managers, told delegates: “South Africans have had a phenomenal 20 years [for investment returns]; don’t expect a repeat performance.”
Rob Forsyth, the global head of research for quality at Investec Asset Management, said: “If we build a portfolio where we are trying to beat inflation by six percent, we think there is a 50-percent chance we won’t be able to achieve that.” He was optimistic, however, that a return of inflation plus four percentage points is attainable.
Are equities still the best investment for long-term growth? If you look at performance track records, including those that go back 100 years, the answer is yes, Chester said. “You have to look long term when investing. The reality is that we are dealing with a risk that is 20 years out, and, for the long term, equities have been the asset class to be, because they have generated the higher returns.”
Chester said volatility and uncertainty provide opportunities. He believes you can find value in a market when there is “so much fear and concern that a lot of shares are priced for the worst possible outcomes”.
At the beginning of this year, when the news in South Africa was “horrific”, Coronation bought domestic assets, which looked cheap. “When a little bit of good news comes along, you can get fantastic returns.”
Lapping said: “The price you pay for an asset matters and is exceptionally important in generating returns. If you buy at a low price, you are more likely to get good returns, and you are more likely to find a low price where there is uncertainty.”
Forsyth said there were places where investors could find value – it comes down to stock selection – but bonds may out-perform equities over the medium term. “In South Africa, you have got to pick your time-frame and, on a five-to-seven-year return, we think bonds will probably beat local equities.”
He said quality companies that generate substantial returns on capital consistently were desirable. “We think we can find enough reasonable valuations offshore.” However, many of these companies are highly sought after, and this is built into their price, making them an expensive buy, Chester said.
“Everyone knows that the high-predictability companies will deliver, and this is built into their price. A lot of the global indices are heavily weighted towards the large companies; it is hard to find value in this space. However, if you look a little deeper, you can find com- panies where the price might reflect value,” Chester said.
Forsyth believes managers need a healthy dose of cash so they can invest when opportunities arise.
Robin Eagar, the head of Stanlib’s multi-asset franchise, had a slightly different view of equity markets. He said it was a myth that you have to be in equities consistently, because they always recover, and that valuations should be high when interest rates are low.
“There is absolutely no relationship between interest rates and returns over the cycle. We go into the market on valuation – that is, we buy equities based on their price relative to the value of the underlying business. The price must offer potential for returns at a premium to cash, risk-adjusted returns.”
Eagar believes investors need to think about wealth preservation, particularly in light of past good returns from equity markets.
Low interest rates and quantitative easing have produced an environment where investment returns have occurred at the beginning of the investment cycle, instead of being spread over the cycle, Eagar said.
As far as fixed income goes, Lapping said the returns in United States dollars of South African fixed-interest assets have been exceptional this year. But if you buy a 20- or 30-year government bond, you have to ask what could go wrong. “To my mind, there is a lot that can go wrong, and we would rather buy a real asset. We are very underweight in long-dated bonds.”
Would a downgrade knock markets? Chester said South Africa already reflects the price of a downgrade. If a downgrade occurred, markets would be expected to move on the day, “but we don’t see a major impact on markets. The bigger issue is why we are getting downgraded.”
Lings said there was a simple solution to improving South Africa’s economic growth: encourage corporates to spend on fixed investment projects such as water supply and other critical infrastructure. They have good balance sheets and over R600 billion in corporate deposits, but lack confidence.
“Make the corporates as confident as you can.”
Lings said this would require political will and “right now it is not there. If we continue with business as usual, we will be junk status. I keep hoping we will get past the political impasse and focus on how we grow this country.”