Tried and tested equities to anchor portfolios this year

Gareth Stokes, FAnews Online Editor

It is common knowledge that equities outperform other asset classes over the long term. This fact is drummed into us by fund managers and investment analysts at every opportunity. But they seldom address how many years make up this “long term”. Are we tal

What can we learn from the asset class returns as published above? The first lesson is that riskier asset classes produce more volatile returns. Equities, which delivered +18.2% compound average annual returns over nine years, limped to an 8.1% per annum performance over five years due to terrible stock market performances in 2008 (-25.7%) and 2011 (-0.4%). This volatility of return exhibits in the annual return on the JSE All Share index, beginning 2007, of 16.23%, -25.7%, 28.63%, 16.10% and -0.4%. Lower risk asset classes such as bonds and cash produce more consistent annual returns… A second valuable lesson is that asset classes can experience periods of phenomenal out performance. Few would bet on listed property repeating its nine year performance over the next five years, for example. Based on the above statistics we believe a sensible “long term” investment time horizon to be no less than 10 years.

Getting the asset allocation right...

It is up to fund managers, in light of their respective investment mandates, to ensure the asset allocations within their funds produce optimal returns for investors. To get the balance right fund managers must take both short and long term views on asset class returns. Their longer term view will typically favour equities over listed properties, cash and bonds… What should they be doing over the next 12 to 36 months? To find out we attended a market outlook presentation by Chris Gilmour, an investment analyst at Absa Asset Management: Private Clients. He kicked off proceedings with a reflection on the slow pace of the global economic recovery. “This stock market crash is no different to those that have gone before, aside from the recovery time frame,” said Gilmour, before turning his attention to recent news out of the United States.

The rollercoaster US employment statistics aside, one of the best measures of US market prospects is earnings. Analysts in the developed world obsess over quarterly earnings performances, tracking companies’ actual earnings against their forecasts, and considering whether their forecasts were exceeded or not. Their obsession has blurred the line between a strong market recovery and one in which companies are clawing back from a terrible recession. Gilmour explained the phenomenon with reference to US-based aluminium giant Alcoa (NYSE: AA). Analysts were so impressed with the company for exceeding consensus earnings forecasts that they lost sight of the fact its Q1 2012 net earnings were 70% down on the previous year!

Gilmour observed that Apple Inc (AAPL), which accounts for approximately 5% of the S&P 500, is now large enough to distort the index… And the “feel good” sentiment around US shares is at least partly due to recent performances from the computer manufacturer! But a few standout performances aside the outlook for US equities is not great. “The outlook for earnings at some of the larger S&P companies is good, but we aren’t likely to see a more favourable price-to-earnings level in the near term,” said Gilmour. Until investors are prepared to back the market at a higher price-to-earnings (PE) level share prices will languish. For this reason Absa Asset Management finds no compelling reason to be overweight offshore (equities) at present.

Placing South Africa Inc under the microscope

South Africa’s economy is driven by consumers, who account for approximately 60% of GDP. If you want to forecast consumer expenditure all you need is an accurate idea of where interest rates are headed, because there is an inverse correlation between retails sales and prime rates. “We are probably not too far away from an upward move in interest rates,” noted Gilmour, before reminding the audience that 18 months back investors were talking about a rate hike late 2010 or early 2011. (This hike never materialised). There is a possibility the Reserve Bank will  further delay hiking rates to allow the economy more time to recover. Rate hike or not, pressure is mounting on local consumers due to rising administered prices such as electricity, fuel and municipal rates…

Can we make any predictions about stock market performance based on the “stretched” domestic consumer? According to Gilmour retail shares are in expensive territory, while banking and financial sector shares have performed well in recent months. He said that despite the JSE All Share index trading on a PE multiple below its long term average the market was set for another sideways year. After a flat 2011 the index has climbed a mere 2.6%, year-to-date 11 April 2012. Despite the lacklustre first quarter analysts hope that strong corporate earnings and dividend growth provide impetus for equities to emerge as the top performing asset class this year.

Absa Asset Management is therefore overweight domestic equities at this time. They are “at weight” in bonds and slightly underweight in cash and offshore. Spare cash is kept in money market investments to avail of equity opportunities as they arise.

Editor’s thoughts: There are as many views on asset allocation as there are fund managers. And the task of divvying up assets between cash, bonds, equities, and listed properties is further complicated by investors’ diverse needs. Are you happy with our 10-year plus definition of the long term investment time horizon – and do you agree equities make the best investment over such periods? Add your comment below, or send it to gareth@fanews.co.za