Investment insights: zooming in on the third quarter

Reza Hendrickse, Portfolio Manager at PPS Investments

The third quarter was relatively calm compared to the prior two of 2020, with global markets digesting the pronounced year-to-date moves in asset prices, as well as the extraordinary economic landscape we currently face.

One of the defining features of the current state of the world is that financial asset prices, and growth assets in particular, have shown surprising resilience in the face of weak economic fundamentals. This is in part due to their forward-looking nature bolstered by the ever-growing faith in the unwavering support of monetary and fiscal authorities to go above-and-beyond the call of duty to prop up economies and markets.

Another factor at play is the ultra-low yield environment, which has meant that capital has been drawn into risk assets regardless, given the lack of alternatives. With the firm commitment by central banks, such as the Fed, to lower interest rates, it is difficult to see this dynamic shift meaningfully in the near-term, but it is important to acknowledge that there is a limit to how much support can in fact be provided.
In addition, these experimental policies could have materially adverse effects further down the line, such as perhaps significantly higher inflation. To this point, the Fed announced a new framework for US monetary policy in August, in which it adopted an average inflation target to overcome the risk of persistently undershooting the 2% objective. This will lead to them being more accepting of higher-than-2% inflation going forward, rather than pursuing pre-emptive policy tightening as they have done in the past.

Market performance

Despite the stronger rand, global equities still outperformed domestic equities with a gain of 3.8% in rand terms for the quarter, increasing their year-to-date advance to 20.9%. Emerging markets, led by Asia, outperformed developed markets, with the US outpacing Europe and the UK which struggled amid the reintroduction of certain lockdown restrictions.

Global bonds and global property declined 1.2% and 1.7% respectively in rand terms, with US Treasury yields rising into quarter end after reaching a new all-time low, posing a headwind for long duration assets. Global bonds, which are up 27.8% year-to-date remain one of the best performing asset classes year-to-date, driven by their safe-haven appeal and central bank intervention, which has led to compressed yields. A further tailwind has been the US Federal Reserve’s increased appetite for an array of fixed income instruments including even high yield corporate bonds, as a further stimulus measure.
Whilst in South Africa, the equity market edged 1.0% higher during the third quarter, narrowing its year-to-date loss to -9.8%. Resources shares were once again the strongest area of the market, but financials also proved resilient, while industrials on the other hand fell.

Nominal bonds strengthened 1.5%, against the muted inflation backdrop and another interest rate cut from the SARB. Inflation-linked bonds also gained ground and may continue to find support given potentially limited scope for continued disinflation going forward. South African Listed Property lost another 14.1% this quarter, and although the sector’s market cap has halved this year, its dramatic fall from grace has given rise to select opportunities in this space.

How has the portfolio positioning changed?

We remain confident that our portfolios are well-positioned for the current environment, and this is evident in the encouraging performance over the quarter and year-to-date, under challenging circumstances. Importantly, pleasing near-term performance is the result of decisions made some time ago, and while we saw an opportunity in the pronounced market volatility earlier in the year to adjust the portfolios slightly, we have broadly maintained conviction rather than become overly active in response to near term swings. Throughout this period, we have maintained our overweight exposure to foreign equities, which added meaningfully to performance.

In addition, given our view that domestic bonds were offering equity-like returns, we tilted further in favour of these earlier in the year and away from domestic equity, which we continue to consider hamstrung by the challenging outlook. We continue to favour global over domestic equities, given that the asset class is less constrained by structurally low growth, with a wider opportunity set available for managers to find attractive investment ideas.

This quarter, we continued along the path of deliberately allocating to managers that are more nimble and adaptable in the face of adverse market conditions, and whose investment approach faces fewer constraints, particularly in the domestic market. Truffle Asset Management and Bateleur Capital are examples of managers that have been incorporated in the funds this quarter. We have also continued to build our allocation to Capital Group across the portfolios, and as with all of our managers, this is a high conviction partnership which we are proud of. Capital Group has a very long track record of success that spans the 1930’s Depression, the 1940’s World War, the 1970’s stagflation, the 1987 stock market crash, the 1998 emerging market crisis, and more recently the trio of market crashes in the 2000s (the tech bubble, the Global Financial Crisis, and the COVID-19 crash).

Looking ahead, we remain committed to our disciplined and diversified multi-managed process, applied by our skilled and experienced team of investment professionals. We expect the environment going forward to be no less challenging than before, but take comfort that maintaining the integrity of the process and balancing the respective return objectives with appropriate levels of risk should continue to place our members and clients in good stead.