SA equities: Key to investment returns in a low-return environment

Despite expectations of lower returns from the South African equity market over the next decade compared to the previous one, local equities remain a very important component of an investor’s portfolio given its higher expected returns relative to other l

Peter Brooke, head of Macro Strategy Investments at Old Mutual Investment Group (OMIGSA) forecasts a real return of 6.0% per year from South African equities through 2015. “This compares favourably with our real return projections of 5.5% p.a. from property, 2.5% p.a. from bonds and 1.5% p.a. from cash. Only international equity as an asset class is likely to outperform South African equity over the next five years, with a marginally higher real return of 6.5% p.a.,” he says.

Prepare for lower returns

“Despite pockets of opportunity, it cannot be emphasised enough that, coming off the utopian highs that characterised a large proportion of the decade of the 2000’s, investors need to prepare for lower returns from most asset classes going forward,” stresses Brooke. “Looking back, the decade 2000-2009 was an exceptional one for South African investors, who enjoyed extraordinary above-inflation returns of 17.7% p.a. from listed property, 9.8% p.a. from local equity and 6.1% p.a. from local bonds.”

JSE valuation eroded

Following 2010’s exceptional performance by local equity - the FTSE/JSE SWIX gained 20.9% in rand terms and 34.5% in US dollar terms to be the world’s best-performing major market - the JSE’s previously attractive valuation has been eroded. Its current forward price-earnings ratio of 12.0 times is slightly expensive.

“We expect the market to grind higher this year on the back of decent corporate earnings growth, particularly from the resources sector. But despite this rather subdued outlook, given the current high levels of volatility, there will certainly be opportunities for active and astute fund managers to pick up bargains and add value to the funds they manage,” notes Brooke.

Equities are attractive

This makes equity the best of the local asset classes over the longer term, particularly true in the face of continuing extremely low interest rates. “We expect the Reserve Bank to begin to raise interest rates only by late 2011 or early 2012, and for the up-cycle to be a moderate one. This means that returns from South African cash and bonds investments are likely to remain relatively low for the foreseeable future, enhancing the attractiveness of equity.”

This also implies that the most reliable source of yield for investors going forward is likely to be dividends, rather than bonds, because with lower capital growth expected, dividends will play a more important role in total equity returns.

Advice for investors

The implications for investors are significant. “In the face of lower returns, it’s important for investors to save and invest even more going forward,” says Brooke. “Those who can tolerate equity risk should consider increasing their allocation to equity going forward to get the full benefits of its higher growth potential.”

He adds that if possible, investors should also take advantage of the increases in offshore investment allowances. “We see offshore equity as another important source of returns over the next five years, and now is an opportune time to invest offshore. This is based on a combination of factors, including the current strength of the rand on an historic basis, diversification benefits and improved offshore valuations.”