Supported by central bank stimulus, exuberant markets disregard economic reality

Benedict Mongalo, Chief Investment Officer at Independent Fund Manager at Novare Investments

The Covid-19 crisis is an opportunity for SA to address long overdue structural economic reforms

Investors who are unsure about how to react to the huge amount of volatility in financial markets should keep calm and stay focused on their objectives.

“An important point to remember is that short-term market volatility does not necessarily reflect economic reality on the ground. So, while the recent recovery in equity markets may not signal an imminent return to economic growth, it could certainly be signalling positive sentiment from investors about the future recovery,” said Benedict Mongalo, Chief Investment Officer at independent fund manager, Novare Investments.

However, he added that Novare is not specifically concerned with short-term volatility because the firm’s clients tend to have long-term objectives. “For us, it is critical to stick to the strategic asset allocation and avoid knee-jerk reactions.

“As a multi-manager, we do not specifically target sectors. Instead, we look for managers that are best of breed and possess respective sector expertise. That said, it is evident that some sectors are likely to experience greater headwinds than others. Tourism, for example, comes to mind as likely to experience challenges, while the property sector arguably offers value depending on the credit quality of tenants.”

The numerous listed companies that have deferred or suspended dividends suggests that most corporates are anticipating continued headwinds, in South Africa and globally.

Mongalo said that some of the factors likely to characterise companies that can succeed include low levels of debt and an adequate margin of safety on cash flow generation.

Companies with strong balance sheets are better able to withstand depressed economic conditions. “They will also be able to execute on opportunities presented by low valuations. For fund managers, there are also exciting prospects across various asset classes.”

He cautioned though that significant downside market risk remains due to muted consumer demand, distressed companies, and consensus of a global recession amidst no clear timeline for a return to normality.

In this environment, he sees diversification as an important defence: “Markets will continue to experience peaks and troughs and spreading risk across assets will serve clients well over the long-term.

“The benefits of diversified multi-asset class funds are well documented, with historic long-term data showing their ability to achieve desired investment objectives. In the case of multi-managed funds like those managed by Novare Investments, an additional advantage is that multiple managers are selected and blended to achieve the outcome.”

In this regard, Mongalo said current market conditions favour active managers who can out-perform based on their ability to manage risk.

“Absolutely, our experience is that managers whose investment philosophy and portfolio construction methodologies are underpinned by risk management are likely to go through turbulent times in relatively better shape. While most portfolios saw big drawdowns in March, active managers who could manage the risk had a chance to out-perform market indices. The ability to actively manage risk in portfolios is a key factor that we look for when selecting managers for our multi-managed portfolios.”

Turning to the big picture, Mongalo said the Covid-19 crisis presents the South African government with an opportunity to proceed with structural reforms which have been mooted for some time now. This would substantially improve the prospects for economic growth, which stock prices already seem to be pricing in.