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Optimal asset allocation for your clients

17 February 2021 Gareth Stokes

A selection of top asset managers has put their weight behind equities as the most promising asset class for your clients through 2021. They were participating in an Asset TV Outlook 2021 panel discussion aimed at uncovering this year’s best asset class opportunities. Each of the panellists shared views on the post-pandemic economic recovery and how these views informed their asset class preferences for risk- and return-optimised portfolios. It soon emerged that equities, whether global or local, were the flavour for the New Year. “Fixed income is expensive, and you are likely to get a negative real return from the class,” said Peter Brooke, head of macro solutions at Old Mutual. He observed that it was easy to take a bullish stance on equities given strong earnings forecasts for the next 12 to 18 months, low interest rates and unprecedented fiscal stimulus.

The search for yield

Omri Thomas, director at ABAX Investments agreed with the ‘long equities’ view. “Global investors are looking for yield again, which forces them into equities, because that is one of the few asset classes where there is yield and growth on offer,” he said. He singled out the massive global monetary and fiscal stimulus as the main support for equity valuations, before lamenting the lack of asset class alternatives to generate real return. Another pro-equity argument, courtesy Iain Power, portfolio manager at Truffle Asset Management, was the “resynchronisation of growth as economies emerged from COVID-19”. He said that the strong earnings recovery through 2021 and into 2022 would benefit cyclical equity assets, which had come under pressure in 2020. 

There was some bad news for South Africa. “We, as an investment house, are more cautious on South Africa’s growth outlook beyond 2021 relative to other economies in the world,” said Brian Thomas, co-portfolio manager and retail analyst at Laurium Capital. There is a risk that South Africa misses out on the synchronous growth that is forecast for developed markets due to the country’s slow start on its vaccination journey. South Africa was also criticised for missing out on growth opportunities. Brooke used the example of the 5G spectrum auction which has been beset by unnecessary delays and questionable decisions on bid participants. “There are attractive businesses in SA, especially in the small and mid-cap space; but it is critical for those businesses to deliver their own future. They cannot rely on the economy or government to trade out of the current situation,” he said. 

Comparing apples with apples

The conversation soon turned to optimal portfolio construction for SA-based investors. Asset managers were asked to share their views on returns and risks in bonds, cash, equities and property. Before we share their responses, we remind readers that asset managers are limited insofar their allocation to the various asset classes by regulation 28. It is also important to understand the type of fund an asset manager is running, because a balanced fund has a different mandate and risk and return profile to an equity fund. “Balanced funds have to have a component in fixed income,” said Brian Thomas. “To race a balanced fund directly against the equity market is not fair because you are not comparing apples to apples”. 

Brookes said that the highest actual domestic return was likely to come from SA property; but warned that return expectations were offset by a bad theme and secular problems in that asset class. Brookes believes that SA equity, SA bonds and global equity are neck-and-neck, offering around 4.5% real return through 2021. But SA cash, global bonds and global cash were considered ‘no go’ areas that will offer low to negative real yields. “We are very underweight asset classes offering negative real yield,” said Brookes. “We have a lot of global equity because it is our most attractive global asset; we diversify this asset class by adding emerging market and value opportunities in an attempt to boost return”. The asset manager is overweight SA bonds; but has started to fade out of this asset class in favour of opportunities in SA equity. 

Maximum to equities and offshore

ABAX Investments remains at its maximum offshore exposure in most of its funds, due to concerns over South Africa’s fiscal challenges. “Within global, we have little appetite for bonds and cash, with equity our preferred asset class,” said Omri Thomas. The asset manager believes that the United States’ equity markets are more expensive relative to the rest of the world, so they have a bias away from US equities and specifically US technology shares. Their domestic equity allocation is split between locally-listed shares with big exposure to offshore markets and the so-called SA Inc shares. “You want to be overweight SA equities, with some bond exposure and cash as a balancing item,” he said. 

Most of the asset managers have increased the offshore component of their funds to the maximum limit allowed under regulation 28. “We have pushed our offshore equity close to its max,” said Power. Truffle Asset Management prefers equities, whether local or offshore, and expects to increase equity exposure into 2021. They also agree with separating local equities into externally-focused shares versus domestically-focused SA Inc shares. “We are fairly optimistic about the world getting a lot better in 2022 and that reflects in big allocations towards economically-sensitive, externally-focused names alongside some attention to SA Inc shares that are good businesses, offer strong dividend yields and are trading on attractive multiples,” concluded Power. 

Another common refrain that emerged during the panel discussion was that South Africa’s long duration bonds were increasingly risky. Asset managers are cautious about the country’s economic path and have warned that uncertainty around state debt would translate to volatility in the domestic bond market. Brian Thomas said that his funds were slightly underweight SA Inc and at weight for SA bonds. “We are [also] sitting at the 30% max that we can invest outside the country, mostly in equities, with small pockets of corporate credit,” he said. Laurium Capital has increased the offshore component of its fund to 33.5% by allocating some capital to African Euro Bonds, which presently yield 6.8% in US dollars. 

Poor growth and fiscal concerns

There are concerns about South Africa’s growth outlook and fiscal position. Rising state debt poses significant risk to the country’s bond market with the possibility of higher inflation and prescription, among other policy responses. “There is tail risk in some of the long duration bond assets, notwithstanding attractive real yield,” said Brian Thomas. Most asset managers are thus sitting in the sweet spot of the bond market at around 8-10 years duration. It is also prudent to seek higher yield in the local equity market, preferably among cyclical shares, than to buy longer duration bonds. “As inflation picks up you want to have maximum exposure offshore and to shares that are coincidentally listed in SA,” concluded Brooke. “You want inflation protection as opposed to fixed income”. 

Writer’s thoughts:
Asset allocation and appropriate diversification within asset classes are critical to achieve your clients’ long term investment outcomes. Nowadays, financial advisers have an expansive universe of collective investment funds from which to structure diversified investment solutions. How do you approach the asset allocation discussion with clients, or are you content putting them in a balanced fund and allowing asset managers to handle the crucial decisions? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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