The art and science of investing in global equities

Adriaan Pask, Chief Investment Officer at PSG Wealth.

In unpredictable times when asset prices appear to ignore valuations, choosing an asset class to secure a reasonable return has become a bit of an art form. Although investment decisions should always be underpinned by science, or objective quantitative assessment, allocations do depend on what the investment is required to do, and the amount of risk you are prepared to take.

Relative to our current valuations, global equity, although trading at a slight premium of 19.3%, is the most attractive asset class.

In comparison, domestic equity is now roughly overvalued by 38% relative to its historic yield, while domestic listed property is now overvalued by roughly 24% relative to its historic yield.

In addition, we believe that the interest rate cycle will affect domestic economic strength, affordability and sentiment. These are headwinds for capital growth in the listed property sector. We therefore expect property yields to normalise on the back of capital value pressure.

The aggregate yield of the BEASSA All Bond Index shows that this asset class remains generally overvalued. The implied premium is roughly 25%. With money market assets starting to offer some value, demand for bonds may decline in light of the increased risk of holding them. The relative risk-adjusted returns of bonds are also being compromised by higher interest rates on the horizon. Until recently, the gross real yield on most short-dated money market assets was nearly zero; and on an after-cost, after-tax basis, there was very little to be excited about. We do, however, expect this to change over the coming months, as rate hikes are anticipated. Cash should form part of a diversified portfolio and even in an increasing interest rate cycle, should not be used in isolation.

The art of investing offshore

As professional investment managers, we are comfortable with determining the intrinsic value or risk associated with each asset class. But the days when valuations provided the main insight into potential value or risk are long gone. Today, investors understand that investment potential is also determined by management, macroeconomic conditions and the political landscape. In essence, the environment in which earnings must be generated plays an increasingly important role in how we assess investment potential and risk.

When we analyse global stocks, we look at the sustainability of the business and its earnings. Businesses should generate a lot of cash, with strong corporate profits and a lean balance sheet with little debt. This enables the business to absorb macroeconomic shocks. Only once we have a sense of comfort about this, will we start considering valuations and other quantitative measures. Having sight of the bigger picture enables us to make sound investment decisions. We also focus on selecting fund managers who actively analyse shares according to these criteria.

We prefer global stocks to domestic shares because generally offshore shares provide more opportunities. There is a greater probability of us finding a good business at an attractive price. Part of the art of investing in offshore equities is the ability to stay the course and not be tempted to chop and change your decisions. This art form has, however, always been informed by our science or quantitative analysis.

The science behind finding value in global equities

The S&P 500 generated a return of 13.60% over the past six months, which brings the five-year historic annualised return for the S&P 500 to 14.69% in dollar terms. The FTSE 100 generated returns of 8.84% for the past three months and 11.23% for the past six months – in other words, it continued to generate positive returns despite the unexpected Brexit vote in June. The US has, however, been the primary driver of global stock market returns, as the S&P 500 was the only major global index that grew by more than 10% over the past year. Combined with the weakness in the rand over the same period, this has resulted in phenomenal returns for investors who diversified offshore.