Is local still lekker?
Diversification has always been Rule Number One for any sensible investor, regardless of his or her domicile, and that remains the case now. But where should South African investors diversify and what should they avoid at this point in time?
This is the question that Rowan Williams-Short, Investment Director of Nedgroup Investments in the UK and manager of the Nedgroup Investments Equity and Balanced Funds attempted to answer at an Association for Collective Investments’ forum for financial planners, fund managers and intermediaries in Cape Town.
Williams-Short said that local government bonds were not attractive, given prevailing yields and inflation rates. Government bonds in the rest of the world were also delivering very low yields. The JP Morgan world government bond index is currently yielding only 3.41%. This weighted average yield is brought down by Japanese government bonds as Japan has the single biggest country weight in the index but its bonds yield just 1.37%.
Turning to local equities he said many market commentators voiced concerns about what they call a “foreign investor sell-off” in the South African market, but that there was no correlation between this phenomenon and the performance of the JSE. Therefore this is one popular concern that he dismissed. Using 20 years of monthly data he showed that the correlation between foreigners’ net buying / selling activity and the market’s moves was essentially zero. The same is true of the local bond market. He went on to explain how this should, in fact, be the case.
The FTSE/JSE All Share Index has outperformed Wall Street (the S&P 500 index) by 263% from 2000 to 2008 in dollar terms, and since 1960 the JSE has beaten the S&P 500 index by 72%. However, the staggering moves of this millennium have rendered the local market no longer cheap in a global context. “The market is becoming a bit expensive at a P:E of 15,” says Williams-Short. Historically, when this ratio has approached parity to the S&P500 P:E, the domestic market has subsequently underperformed Wall Street, when both are measured in dollars. Furthermore, the JSE is now at a 37% PE premium to the FTSE100 index in the UK.
He reminded the audience that the local market was exposed to ‘emerging market contagion’, meaning that South Africa was far more vulnerable to socio-economic or socio-political upheavals in other emerging economies than were developed economies. Accordingly, he believes that other emerging markets are inappropriate for South African investors and do not constitute good diversifiers. These include the popular equity markets of Brazil, Russia, India and China (the BRIC’s). In addition, emerging markets in general have become more expensive than developed markets.
“The world’s ten largest emerging market economies represent only 17% of the world’s total GDP, so why would one invest there and not in the other 83% that represents developed market economies?” he asked.
He concluded that while the JSE was not cheap overall, it is still possible to construct a well diversified yet cheap portfolio of domestic shares (the P:E of the Nedgroup Investments Equity Fund, for example, is just 10) and that the most attractive assets into which South African investors should currently be diversifying were developed country equity markets.
