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Piloting through the storm brings opportunities to buy

31 March 2016 Rob Spanjaard, REZCO Asset Management
Rob Spanjaard, Chief Investment Officer at Rezco Asset Management.

Rob Spanjaard, Chief Investment Officer at Rezco Asset Management.

Few would disagree that South Africa is currently in a veritable economic storm. However, economic storms also bring informed investors opportunities to achieve decent returns, as long as you play according to the rules.

This is according to Rob Spanjaard, Chief Investment Officer at Rezco Asset Management, who says, “We are in a bear market currently, with low world economic growth, and investors have arguably taken some of the pain already. I believe we should start to see some great buying opportunities unfolding over the next year.”

“However, to use the analogy of a pilot flying through a storm: you need to be prepared for the bad weather conditions; you need to use objective instruments in planning your flight path; and you must not react to the difficult environment with emotion, but rather keep a cool head even when others around you may be panicking.”

Spanjaard warns investors to expect continued market volatility and big drawdowns going forward. He clarifies, “You get these major volatility swings at the end of a bull market. In addition, South Africa itself is at a crossroads with regards to our credit rating status and our general standing in global economic circles.”

“There are many potentially negative scenarios that could unfold in the near future. These could consequently have a huge impact on both the market as well as investors’ general decision-making requirements, for example, whether or not to hold equity.”

Spanjaard says South Africa is currently finding itself in a situation similar to that which recently rocked Brazil, namely suffering from the ‘triple whammy’ of a political crisis, an economic crisis and a crisis of confidence in the country’s leadership.

“This combination obviously leads to great uncertainty about the country’s future from an investment perspective. We need to be very careful not to encourage perceptions of the country that will equate us with the recent unfortunate events in Brazil that led to its credit sovereign downgrade to junk status[1].”

Spanjaard says, however, that he fears Moody’s will downgrade South Africa, which would no doubt be followed by further downgrades by the two other major agencies. “This is not good for attracting and retaining foreign investors. Some overseas-based pension funds, for example, are, according to their mandates, not allowed to own bonds of junk status.”

“Finance Minister Pravin Gordhan has been doing an admirable job since he took over the hot seat once again, but against a politically unstable background, investors’ perceptions of South Africa as an investment destination are nonetheless being tainted by the current uncertainly. Foreigners have been selling off local bonds and equities and we need them to support us. So how, then, as investors do we navigate through the storm?”

Spanjaard advises investors to expect the volatility to continue. In cricket parlance you could also say that we are on a ‘low scoring pitch’. In this analogy, a good defence strategy is critical – which is the same warning we gave last year. Against this background, we recommend investing in good balanced funds, where the fund managers will take you through the volatility by – appropriately - increasing or decreasing the exposure of the fund to different asset classes.

“The result should be that portfolio managers who do their job correctly manage to reduce the downside that their funds experience but at the same time profit from a significant portion of the upside. Managing capital gains tax is also easier through a balanced fund, and with a balanced fund you should also expect your drawdowns to be a lot smaller. In addition, I believe we are closer to a buy area than we were in 2015, which is at least some good news as it means that we are in a better space than a year ago.”

Spanjaard advises further that investors should also look for investments with a good upside-downside capture ratio. “Probably one of the best ways of measuring this is using Morningstar’s Capture Ratio. This gives an indication of how much of the upside in a bull market a fund was able to participate in and how much of the downside in a bear market the same fund participated in.”

Finally, Spanjaard advises that when building a portfolio, it is best to find funds with a low correlation to each other. “You don’t want to include three or four funds that do essentially the same thing, no matter how good the managers may be. One of your best defence tools is to find funds that behave differently from each other. Be careful of picking your favourite funds that behave very similarly to each other.”

Spanjaard concludes by advising that when selecting a balanced fund, investors should choose funds that have a long-term track record (5 years or more) as well as fund managers with a proven history of being able to manage money through both bull and bear market cycles.

1. The world’s three major global credit rating agencies, Standard & Poors, Fitch Ratings and Moody’s, downgraded Brazil’s sovereign credit rating to below investment grade, or ‘junk’ status, between September 2015 and February 2016.
2. While the portfolio manager will attempt to minimise risk, it is possible that the investor could incur losses, including the loss of principal invested.
3. While the portfolio manager will attempt to minimise risk, it is possible that the investor could incur losses, including the loss of principal invested.

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