Defensive strategies to navigate your clients through volatile markets
As 2024 winds to a close, disciples of the value investing methodology will be tilting their multi-asset portfolios towards offshore equities; local bonds and cash; and South African companies boasting attractive valuations. This “investing for uncertain times” strategy was shared during a recent fund update presentation held under the title The Times with Allan Gray.
A mixed bag, but net positive…
Portfolio manager, Sean Munsie, took to the virtual stage to update an audience of independent financial advisers (IFAs) and their clients on the brand’s domestic fund performances, and offer insights into how the asset manager’s investment process accommodated different market scenarios.
He noted that over a 12-month view, the three funds in the Allan Gray stable had delivered strong absolute returns, all exceeding their three- and five-year average returns. Munsie observed that the Equity Fund (+16.8%) and Balanced Fund (+14.2%) were lagging slightly against their benchmarks, but that the Stable Fund (+11.6%) was nicely ahead of its cash-plus-2% target.
“Our goal within the investment team is to construct a portfolio that will do well under a variety of circumstances, and it is fair to say that how the environment evolved within the local context has been very beneficial for local asset returns,” the portfolio manager said. He reiterated the firm’s investment philosophy as one premised on value. Put differently, the investment team goes to lengths to ensure they do not overpay for assets. The result is that the funds’ one-year returns tend to lag slightly during periods of strong market return and outperform through market drawdowns.
“Our investment philosophy really comes to the fore in more difficult, trying markets,” Munsie said, illustrating how the bulk of 20-year outperformance across the three funds in question coincided with corrections or pullbacks in financial markets. The focus on deep value offers somewhat of a buffer when share prices fall; if a share is already cheap, it usually has less to give back than the so-called high-flyers. The discussion flashed back to the investment landscape entering 2024. Just 12 months ago, IFAs would have been warning their clients of the potential negative influence of a range of uncertainties.
Drama trumps democracy as US hopefuls square up
Munsie referred back to various of these challenges to reflect on their subsequent market impact. First up, national elections. 2024 has been widely recognised as a ‘mega year’ for important elections, with the granddaddy United States (US) elections underway as this newsletter ‘drops’. South Africa benefited from a decent election outcome and a strong uptick in local equities; but asset prices in countries like France and Mexico took a hit after their electorates went with candidates who were considered ‘left’ leaning. All eyes now turn to the US, where the Harris versus Trump battle has the hallmarks of a Hollywood drama rather than an exercise in democracy.
Another trend giving asset managers sleepless nights entering 2024 was that of inflation and interest rates. Mostly, they were concerned about the timing of the pending inflection point for Western interest rate cutting cycles, and what these might mean for company earnings and the return profiles of various asset classes. Munsie discussed this point in the context of the oft-repeated 5-Ds that are driving structurally higher inflation, including de-globalisation, demographics, decarbonisation, debt and defence spending. Some interesting insights were shared under each point.
Inflation drivers: from climate change to war
Climate change is top of mind as the COP29 conference nears, so we may as well begin with decarbonisation. “Replacing an efficient (albeit dirty) fossil fuel energy system with one that is cleaner is going to come with costs,” Munsie said, and create inflationary pressures. De-globalisation, meanwhile, is undoing the multi-year low-inflation benefits of globalisation. “Globalisation has exerted massive deflationary pressure on prices for the last two decades or so; if anything, we have seen some of those tailwinds turn into outright headwinds as countries refocus internally,” he said. As for conflict, it turns out inflation and war are synonymous going back to WWI.
The audience was warned against interest rate and inflation complacency, with the presenter sharing a long-term graph of US inflation data. “We have seen a step down from the initial spike over the course of 2022 and 2023; but if we compare the current inflationary cycle to the last time the world experienced heightened inflation … you can see that inflation does remain higher,” Munsie said. Case in point, the US inflation prints have remained stickier than expected year-to-date 2024. The risk here is that portfolio managers have positioned their portfolios for steep interest rate cuts through 2025, which then fail to materialise due to inflation worries.
Turning inwards to South Africa, the presenter spent some time on the domestic outlook under the post-election Government of National Unity (GNU). At first glance, it seems businesses and consumers have latched onto the GNU as some type of sentiment enhancer, chasing confidence indices way higher than they should be. According to Munsie, the yield on South Africa’s 20-year government bond moved more than 200 basis points lower in response, to levels last seen pre-pandemic.
The fiscal picture is somewhat messier
This was “despite some of the fiscal metrics screening noticeably worse” including the debt-to-GDP ratio weakening from 56% to 74% and the percentage of tax revenue ‘ring-fenced’ for interest payments on government debt jumping from 15 cents in the rand to 21 cents, excluding additional Eskom-related borrowings. “A lot of the rally [in bond markets and on the JSE] has been sentiment-based as opposed to investors responding to concrete reforms and policy implementation,” Munsie said.
To maintain current price levels, investors are going to begin demanding visible improvements in these areas; in fact, there has already been a bit of a correction. “In the last few weeks, we have seen some of this rally unwind with bond yields moving 50 basis points higher (on the 10-year note) … though this is less of a South Africa and more of a risk story,” he said, before dedicating some time to everyone’s favourite emerging market (EM) currency, the rand. As most FAnews readers will know, the rand has been on a bit of a tear of late, ranking among the best-performing EM currencies year-to-date. The remaining sticking point in the currency and bond yield context is that South Africa has a much higher debt-to-GDP ratio than many of its EM peers.
The presentation offered some positive macroeconomic developments that could support the domestic economy in coming months, including the end of load shedding, and the start of an interest rate cutting cycle which should ease the burden on consumers. Early reports from retirement fund administrators suggest that withdrawals under the recently implemented two-pots retirement solution could drive a nice ‘bump’ in consumption expenditure too, adding a few basis points to the eventual 2024 GDP number.
Finally, some insights into asset allocation
The asset allocation part of the talk focused on the make-up of the Allan Gray Balanced Fund. “Given the uncertainties within both the local and global market, we are trying to construct a portfolio that can cater for a wide range of potential outcomes,” Munsie said. “This fund remains weighted to offshore assets, be it direct offshore or foreign-facing businesses listed on the JSE.” SA bonds and cash and SA-facing listed equities make up about a third of the portfolio, which also holds small allocations to precious metals and hedged equities.
For its allocation to SA shares with exposure to the domestic economy, the fund seeks out a mix of companies at attractive valuations, focusing on firms that have some sort of self-help capability to drive earnings growth. And for SA shares that reference foreign businesses, the preference is for defensive shares that offer attractive valuations, such as AB InBev, Glencore or Mondi Limited. PS, none of these portfolio musings constitute financial advice.
“We do not know what the future holds; our investment process includes assessing the likelihood of different scenarios occurring and what the expected return may be if those scenarios do prevail … we then construct portfolios that are defensive to adverse scenarios,” Munsie concluded.
Writer’s Thoughts:
The latest macroeconomic indicators suggest business and consumer confidence in South Africa’s investment outlook are overdone. Is this reality prompting you to rethink your clients’ portfolio allocations? Please comment below, interact with us on X at @fanews_online or email us your thoughts [email protected].
