Making sense from nonsense. How to navigate your discretionary investments post pandemic
One of my favourite investment quotes is by renowned economist, John Maynard Keynes, who observed that “markets can stay irrational longer than you [or I] can stay solvent”. Those seeking experience to support his statement should try their hands at trading shares in today’s turbulent and volatile offshore markets. Shares on the US S& P500 index followed record losses in March 2020 with its fastest single-month recovery since 1987, up 13,2% over April 2020, despite shocking job losses and weak economic data. All three major US share indices have ignored economic fundamentals to trade back to near record levels.
Slumping economy, surging market
Sean Markowicz, a strategist at global asset manager Schroders, explained this disconnect during a recent podcast discussing the global market outlook. He set out to answer the question: Slumping economy versus surging stock market, what is going on? “Stock markets are going in the opposite direction to the economy,” he said. “It seems counterintuitive; but there is plenty of evidence that points to a weak relationship between stock market returns and economic growth”. Share prices are uncorrelated with economic data because they are forward looking. What this means is that today’s price incorporates everything the market ‘knows’ about the company today, plus the net present value of the company’s future earnings, based on the market’s best estimation.
A second reason for the disconnect is that the weights assigned to shares in an index have no link to their real economic contribution. “The stock market is not the economy,” said Markowicz, adding that the highest weighted share in an index could have a limited impact on the economy through growth and jobs. Another way to illustrate the concept is that US small businesses, which contribute around 44% to the US economy, hardly feature on the S&P 500. The mere fact that the economy and stock market are uncorrelated does not, however, mean that offshore shares will continue their upward trend. Many economists are now arguing that the world might enter a recession similar in magnitude to that of the 1929 Great Depression, which wiped off 86% of the S&P 500 over 34 months.
Another great depression looms
“There is more than enough evidence in the post pandemic makeup to suggest that we should be paying close attention to a depression scenario,” writes Dr Adrian Saville, chief executive at Cannon Asset Managers. “Markers for concern include a collapse in vehicle sales; the imposition of trade barriers to protect domestic markets; falling commodity prices; a wave of consumer debt thanks to easy money; a dive in the federal funds rate; a surge in unemployment; sharp market swings; deepening fiscal deficits; and the risk of a deflationary price spiral”. Against this backdrop, he argued, asset managers should position their portfolios for “a world of higher rates of price inflation, [increasing] government spending stimuli, nominal interest rates of near zero, and negative real interest rates”.
Duggan Matthews, Chief Investment Officer at Marriott, follows an investment philosophy that favours high quality, diversified, and resilient companies that are usually held for the long term. In a recent media release the asset manager shared some of the characteristics to look for when ‘picking’ shares. First on the list, is diversification, a buzzword that most investors are familiar with. You can diversify across asset classes, across stocks in sectors, or across products in a single company. A second important characteristic is that the company exhibits market leadership. “Visa, the number one global credit card network, has recently been included in the Marriott portfolios for their market leadership characteristic in particular,” said Matthews. He said that companies should also be innovative, show resilience, and offer robust margins.
The ‘surest’ form of risk management
Cannon Asset Management weighed in on the diversification debate, calling it the ‘surest’ form of risk management and a ‘free lunch’ available to every investor. “Diversifying your portfolio across asset classes, geographies, currencies, and industries has a surer prospect of getting you to your investment destination than investment decisions that, in the absence of diversification, could be perfectly right or exactly wrong,” wrote Saville.
Investors should, however, avoid treating all industries similarly – especially as the world emerges from pandemic. “There are industries where the entire business model is vulnerable, because they rely on face-to-face interaction, such as airlines, auto manufacturers, and other cyclical components of the market,” said Markowicz. He observed that some of these industries could fail without government bailouts. Schroders also signalled early concerns about the valuations on US-based technology firms.
“Large tech firms face a lot of criticism for anti-competitive behaviour, from data privacy issues to unfair business practices, and it is possible that regulation could have serious implications for their growth prospects,” said Markowicz. He also commented on the so-called ‘winner’s curse’ which saw dominant firms struggling to maintain their leading positions over time. A paper by the McKinsey Global Institute finds that nearly 50% of all market leaders fall out of the top 10% of the index during each business cycle. So, beware the FAANGs (Facebook, Alphabet, Apple, Netflix and Alphabet).
Ways to invest offshore
The most convenient way for South African investors to gain offshore exposure is via one of the many unit trust funds that are mandated to invest a portion of their assets under management offshore. These locally-administered funds are reported on by the Collective Investment Schemes (CIS) industry under the ‘Local Funds’ heading and are mostly found in the ‘Global Funds’ or ‘Worldwide’ Funds sub-categories. The percentage exposure to offshore assets will appear in the unit trust fund mandate. Those who prefer direct exposure to offshore assets have two options in this space.
The first is to invest in a rand-denominated unit trust that feeds into and derives its ‘price’ from a foreign currency portfolio, held offshore. These so-called feeder funds make use of the asset managers’ asset swap capacity, allowing your investment to remain in South Africa. You will not use up any of your offshore allowance under this arrangement.
Check for regulatory approval
The second option is to choose from among the 500 plus foreign currency denominated unit trust funds on sale in South Africa, which are reported on as part of the Foreign Funds portion of the CIS industry. These funds can only be actively marketed to South African investors if the asset manager is registered with the Financial Sector Conduct Authority (FSCA). Your client must use his or her offshore allowance to access these opportunities because their investment will be domiciled offshore. A taxpayer can take up to R11 million offshore each year: The first R1 million does not require tax clearance; but the next R10 million is subject to both tax clearance and South African Reserve Bank approval.
Writer’s thoughts:
There are countless investment products available to South African investors to take part of their discretionary investment capital offshore. Financial advisers play an important role in navigating the wide provider and product choice to ensure that the chosen investment matches their clients’ financial plans. What do you believe is the most sensible way to achieve offshore exposure for your clients? Please comment below, interact with us on Twitter at @fanews_online or email me us your thoughts [email protected].
