South African investors should consider making hedge funds, which can generate positive returns even in market downturns, a crucial part of their portfolios given the uncertainties facing the global economy, according to Novare Holdings.
A resurgence in inflation reversed the optimism investors had shown earlier in the year for a rebound in shares and bonds as the prospect that higher interest rates would remain in place for longer sank in. Investors had hoped the US Federal Reserve would reverse course after eight interest-rate hikes over the past year. Instead, authorities have now vowed more action with inflation proving stickier than expected, in addition to a strong labour market and resilient consumer spending.
The European Central Bank has also indicated it has not yet won the fight against inflation and has further to go with raising interest rates.
“We are currently in an inflationary bear market,’’ according to Jacobus Brink, the head of investments at Novare. The firm manages R10 billion in clients’ assets. A separate business division advises pension-fund clients with R150 billion in assets. “Normal rules don’t apply.”
He said that a 60/40 portfolio, where investors put 60% of their assets in shares and 40% in bonds in what is considered a safe allocation, no longer works in the aforementioned market regime. In 2022, a 60/40 portfolio returned -18.1% on a nominal basis, the worst year after 2008 since the inception of the Bloomberg US Aggregate Bond Index in 1976.
Less risk
“That’s the benefit that hedge funds bring to the table; they can generate returns when things are volatile, with less risk,” according to Kagiso Mathole, portfolio manager at Novare. Most of the hedge funds in Novare’s funds outperformed their respective benchmarks across all categories last year.
According to data from the Association for Savings and Investment South Africa, assets in the local hedge fund industry soared by an unprecedented 30% in 2022 to R113.01 billion. The sector attracted net inflows of R5.33 billion last year. The hedge fund industry may experience even better growth in 2023 following legislative changes allowing pension funds to invest 10% of their assets into hedge funds and 15% into private equity investments.
Earlier this month, the Financial Sector Conduct Authority, which regulates the financial services industry, said it is reviewing the assets that Collective Investment Schemes like unit trusts can hold. These would include hedge funds, opening the funds to retail investors and providing another avenue of growth.
Brink said South African shares offer better value than US stocks, even after their outperformance over the past year, as emerging markets look set to potentially outshine developed nations in 2023.
While South Africa has its challenges, such as a power deficit, a moribund economy, high unemployment, poorly managed state-owned entities and a volatile political environment, the country’s listed companies are well-managed, cash-flush, and pay solid dividends, with the Johannesburg Stock Exchange defying a slump in global equities last year.
Overweight cash
After getting used to interest rates near zero for over a decade, investors suddenly need to adjust to inflation at the highest levels in 40 years and rates at their highest since 2007.
Novare has shifted its portfolios to overweight emerging-market equities versus developed markets relative to benchmarks. When deciding whether to move funds offshore or keep them at home, the funds have rather stayed in South Africa. Portfolios are also overweight in cash while holding an underweight position in global bonds.
Wall Street experienced its worst annual rout in 14 years in 2022, while the MSCI ACWI Index of developed and emerging market shares declined 20%. The JSE’s All Share Index rose 8.5%. Bonds also fell to experience one of their worst years in decades, with the Bloomberg Global Aggregate Total Return Index falling 19%.
Brink said that the US still faces a barrage of challenges in bringing inflation down against the backdrop of the war in Ukraine and the uncertainties of simmering tensions with China. Listed companies also faced the prospect of earnings downgrades in the coming months as the impact of the global and local economic slowdown filters through.
“The US and other developed markets are not out of the woods yet,” he said.
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