Amid uncertainty, outlook for returns isn’t so gloomy
Although heightened uncertainty has dominated local financial markets since the Cabinet reshuffle and sovereign credit rating downgrade, Prudential’s view on potential investor returns over the medium term subsequent to these events has been less gloomy than one might imagine. The weakness seen in South African nominal bonds, listed property, and financial and retail shares has presented good opportunities for investors to buy up attractive assets at discounted valuations that should produce above-average returns over the medium term.
In positioning our multi-asset portfolios in the “post-downgrade” environment, as valuation-based investors it’s important to note that we have not changed our approach: we continue to place great importance in building well-diversified portfolios of attractively valued assets with the appropriate risk. These characteristics provide some level of inherent protection against future market shocks.
So how are our funds positioned to earn the best possible returns over the medium term? First of all, our portfolios have been, and continue to be, at or near the maximum allowed offshore exposure, which acts as a strong rand hedge. We believe foreign equities in aggregate are priced around fair value, despite the strong run in US equity markets since President Trump’s election in November 2016, as corporate earnings growth has accelerated and the market has re-rated as well. As such, we are neutrally positioned in our offshore equity holdings. And with government bond yields remaining very low across the globe, we are underweight offshore bonds. We prefer foreign cash assets, and are overweight in many of our portfolios since this gives us the ability to take advantage of opportunities as they arise.
Among South African assets, we are moderately overweight equities, nominal bonds and listed property at the expense of inflation-linked bonds (ILBs) and local cash. The FTSE/JSE All Share Index’s 12-month forward P/E, at around 14.1x at the time of writing, is trading just below our estimate of long-term fair value, and is somewhat cheaper than offshore equities. In our selection of shares, our portfolios are overweight well-priced rand hedges like Naspers, British American Tobacco, Sasol, Anglo American and Glencore. We have also been overweight undervalued financial stocks, which remain attractive on a risk/reward basis.
Listed property is another overweight holding for Prudential, having sold off following the Cabinet reshuffle and downgrade. At the time of writing, listed property companies (excluding developers) were priced to return approximately 16% p.a. over the medium-term (assuming no change in the market’s valuation of property), comfortably above inflation and, we believe, ample compensation for the risk involved.
Finally, Prudential’s multi-asset unit trusts have been overweight in South African government and corporate bonds for some time now, and remain so, albeit to a lesser extent. We believe 10-year government bond yields of over 9% following the recent sell-off, as with listed property, offer an appealing return for the potential risk.
Looking ahead, investors can expect ongoing volatility amid higher levels of local and global uncertainty. Overseas we have the heightened political risk stemming from the unpredictable policies of the Trump administration, as well as Brexit and rising populist pressures in Europe, while locally the repercussions of South Africa’s elevated political risk and non-investment grade rating will continue to unwind. Although global conditions are improving, the extent to which we can benefit from this has been dented by our move to non-investment grade status.