Long-term strategies give you clients an edge in volatile markets

The best way to lock in returns through periods of economic and financial market volatility is to remain focussed on longer term indicators and trends. John Gilchrist, CIO at PSG Asset Management, credits a combination of long-term data insights and his firm’s 3M investment process for delivering market outperformance, elevating many of the asset manager’s funds to the top quartile over five and 10-years.

Banking on the 3M process

For those new to the domestic fund management landscape, the 3M process is a three-factor technique to screen for companies that will optimise the risk and return trade off. In the asset manager’s own words: “The first two M’s help us evaluate the quality of companies through the strength of ‘Management’ and evidence of a competitive advantage that serves as a ‘Moat’, setting the company apart from its peers.” The third M is described as a ‘Margin of safety’ or a price level that represents a discount to the market. 

Gilchrist kicked off his presentation to the PSG Outlook 2025 event, held in Pretoria and Johannesburg recently, with a quick wrap of 2024, a global election year. “Last year 74 countries went to the polls, and 1.65 billion people cast their votes; we saw a huge shifts against the incumbents,” Gilchrist said. He gave four reasons for this voting outcome including consumers’ dislike of inflation; a renewed shift towards populism; defence of tradition, traditional values and a pushback against immigration; and finally, voters’ dissatisfaction with how governments were responding to geopolitical crises. 

The ‘elephant in the room’ for global financial markets is the absurd strength of the United States (US). Gilchrist welcomed the impressive returns from the US S&P500 which ended 23% higher last year, building on the 24% return it delivered in 2023; but he warned about concentration risk in that market and globally. “The Magnificent Seven as a group were up 63% in 2024, delivering over 73% of S&P500 returns in that year, and roughly 80% in the previous year.” Globally, the MSCI World Index ended 2024 19% higher with US shares making up an unprecedented 74% of that index. 

No easy path to offshore-onshore diversification

Yes, dear reader, diversifying your clients’ portfolios is becoming more difficult than ever. If you buy the MSCI World, you are getting almost 80% US exposure, and if you buy the JSE Top 40 shares, you end up being massively exposed to commodities and offshore currencies. Your writer will share some additional insights on portfolio diversification later in this article, when he unpacks the latest asset allocations across the asset manager’s Balanced Fund. First, a quick review of domestic asset class performances through 2024. 

Local investors enjoyed a 17% return from the All Bond index, and 13% from the JSE All Share index; but it was not all plain sailing. According to Gilchrist, local investment decision making was dominated by fear over the 2024 National Election outcomes up until end-May, and then by concerns over how political parties would align post-elections. The asset manager realised that valuations in the financial and industrial complex were under pressure in March and April 2024 and was able to build exposure to quality SA Inc shares at attractive levels. 

These shares powered ahead through the second and third quarters but started losing momentum towards year-end. Despite 300-plus days without loadshedding, optimism around the Government of National Unity (GNU) process, and lower interest rates, the markets remained wary over the GNU’s long-term sustainability. Questions centre on whether the GNU will ‘hold’; whether it will deliver much-needed reforms; and whether these reforms will translate into growth. Recent fallout over the enactment of the BELA Act; Expropriation Act; and NHI Act have heightened concerns, especially over the short-term.

Building portfolios for uncertainty

How does one position a portfolio in an uncertain world? “We know broadly how we want to position our portfolios over the long-term; but we do not hold assets simply because they are going to mitigate risk,” Gilchrist said. “We do not believe in holding something that is expensive just for portfolio characteristics, [rather] we look holistically at how we can address risk at an overall portfolio level to get the right risk outcome.” 

Going into 2025, there were countless red flags under headings like consensus, confidence, complacency, concentration, and valuation, to name a few. Here are some PSG Asset Manager insights into each. 

• Consensus: The level of consensus among asset managers entering the New Year is cause for concern. According to Gilchrist, a word map built up from dozens of 2025 outlook presentations is riddled with phrases like America First, US Exceptionalism, and Tump 2.0. He conceded that the US has created an awesome environment for companies to thrive and grow earnings, but warned against investing on the assumption that the trend would continue indefinitely. 

• Confidence: Citing the latest Bank of America Global Fund Manager Survey, Gilchrist noted that despite concerns over the inflationary impact of the fiscal cliff, tariffs, and a potential international trade war, US funds had the lowest allocation to cash going back 25-years. “Far more concerning for us, is that we are seeing the biggest overweight to US equities in the survey’s history,” he said. The US funds are overweight US equities, and US equities are overrepresented in the MSCI World. 

• Complacency: Market commentators are ignoring the red flag of a stubbornly low volatility indicator despite high levels of uncertainty ex the US economy and financial markets. “The US represents an incredibly uncertain, unpredictable and noisy type of environment; but despite this, the VIX is sitting at about 15%, substantially below its average,” Gilchrist said. 

• Concentration: There is an element of craziness in global fund concentrations presently, with money flowing into the US on the basis it is the only place to invest. As already mentioned, the S&P500 is dominated by large technology shares, and the MSCI World index by US companies. 

• Valuation: “The S&P500 has been growing quite a lot ahead of trend, and that is expected to pick up over the next year, [demanding] exceptional levels of earnings growth,” Gilchrist said. He opined that current price levels showed stretched earnings and stretched valuations based on those stretched earnings. Put differently, the US markets are too expensive, and there is too much market noise presently. 

Opportunities in uncrowded markets

“We like to look at uncrowded areas of the market because they generally are quite cheap; we find shares or opportunities that are great quality but are not recognised by the market,” Gilchrist said. Entering 2025, these out of favour opportunities will come from commodities, emerging markets, energy, the Eurozone, materials and staples, to name a few. 

To spark some controversy, the CIO ventured that it was not beyond the realms of possibility that the coming decade might be a ‘lost decade’ for US equity markets. Why? Firstly, the Shiller PE ratio is at record highs, around 35 times. Historically, the higher this ratio, the lower the subsequent 10-year returns. Secondly, there is potential for a weaker US dollar, despite Trump’s focus on protectionist policies. “We think there is going to be a lot of pressure in terms of the fiscal situation, and we do not think the US is immune [just] because it is a reserve currency,” Gilchrist said. 

South Africa has potential, with the usual caveats. PSG Asset Management suggested that a combination of business confidence, loadshedding reductions, and transport and logistics improvements could boost GDP to 2.5-3% in the coming year. “The correlation between business confidence, consumer confidence, and GDP is very strong,” Gilchrist said, before offering up his Balanced Fund as a template for asset allocations. His starting point is to be pragmatic and build a portfolio that works for clients over both the short- and long-term. 

Balanced fund asset allocation

For 2025, the manager’s Balanced Fund exposure is divided 54% to South African risk, and 46% to offshore and resources. The fund runs a stronger South Africa Inc ‘tilt’ than many of its competitors due to having adequate capital to explore mid- and small-cap opportunities. Entering 2025, the fund held 33,2% in SA Inc equities; 20,8% in SA bonds; 11,3% in local resources; 9,1% in offshore resources; 6,2% in JSE-listed rand hedge shares; 18,0% in other offshore equity; and 1,3% in foreign bonds. 

As advisers, you have to trust your asset management partners to keep their eyes on market developments and stay the course through periods of market upheaval. A recent example is the almost 20% correction in US-listed Nvidia; the company shed around USD589 billion in market capitalisation in a single trading day. “As you would expect, we are cautious about large cap technology shares,” Gilchrist said. His main concerns include valuations in the S&P500 and concentration risk, including in passively managed funds. 

Active makes sense, especially offshore

“Active is the place to be [to enable] access to areas of the market outside the large cap, into the small- and mid-cap universe,” he concluded. “You must ensure that you have adequate diversification across your portfolios, invested with different managers … this is how we offer exceptional long-term outperformance to the ultimate benefit of your clients.”

Writer’s thoughts:
Diversification and taking a long-term view are excellent ways to address risks introduced by financial market concentration and uncertainty. How can you help your clients see beyond today’s volatility to focus on sustainable growth over time? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.