Publications
Partners
Battle-scarred investors are buoyed by prospects that global stock markets will deliver better returns this year despite continued political and policy uncertainty in the US, Europe and Britain and lingering doubts over China’s economic slowdown.
The breathtaking rally in US equities following the unexpected election of President Donald Trump in November has had ripple effects around the world and the prevailing view is that prospects are good for improved economic growth in many developed and emerging markets.
US investor sentiment has not been this positive since 1987, and global stocks measured by the MSCI World Index have hit a 19-month peak, while emerging markets are expected to put in a strong performance despite successive hikes in US interest rates.
Appetite for risk is firmly back on the table, and South African stocks are included on the menu – at least for upbeat fund managers willing to look through jitters past the ANC leadership election in December and focus instead on expectations for faster growth, lower inflation, and interest rate cuts in the second half of the year. The JSE closed 0.8% lower last year.
“We are more optimistic on risk asset returns in 2017 […] The political backdrop in SA is still very murky, but it seems like things will be less volatile than last year,” says Rhynhardt Roodt, a fund manager at Investec Asset Management.
“What is clear is that there is a broad-based cyclical recovery underway, not just in the US. There’s quite a change in market leadership – industrial companies tied to the real economy are taking over. It’s time to make money rather than preserve money.”
Roodt nonetheless doesn’t like the US market – he thinks it’s too expensive. In SA, he thinks that the background for local consumers and manufacturers in particular has improved and companies like packaged goods and food manufacturer Tiger Brands, along with agriprocessing and property giant Tongaat Hulett, will do well. “The glory days of SA retail are over but people are underestimating the cyclical recovery.”
Moving investments offshore
Fund managers are unanimous in the view that now is a good time to move money offshore, after impressive gains in the rand, which appreciated by 12.5% against the dollar last year and extended its rally so far this year, touching an 18-month peak at R12.80 to the dollar after the National Budget last month.
Analysts believe that although the rand may appreciate more in the short term, its current level is “fair value”, and in the long term further depreciation is inevitable. Recommendations vary, but financial planners recommend that investors keep at least 30% of their balance sheet offshore.
But basing investment decisions on expectations of a strong recovery in the US economy and elsewhere may be misplaced, as the success of Trump’s pro-growth policies are not guaranteed, warns Tim Buckley, chief investment officer at Vanguard. His company was the best-selling global fund manager last year with nearly $200bn of inflows from clients and more than $4tr in assets under management.
One of the main reasons for Vanguard’s impressive performance is that it is owned by clients rather than shareholders, who have a vested interest and are willing to aggressively pursue a low-cost sales strategy. But more importantly, the fund manager has also embraced the contemporary blueprint of incorporating both active and passive business, rather than sticking stubbornly to the old-school practice of offering the services of financial professionals who scrutinise companies on a daily basis – charging high fees for investors.
Active versus passive funds
Faith in active fund managers has waned dramatically in the past few years, on mounting evidence that very few manage to outperform funds that are linked to the performance of a broad stock index. A staggering three-quarters of South African equity funds underperformed the S&P South African Domestic Shareholder Weighted Index over five years.
On top of that there is a massive, though narrowing, gap in the costs of both types of investments – the average expense ratio for an actively managed equity fund was 1.4% last year, while the average expense ratio for a passive equity fund was 0.6%, according to Thomson Reuters Lipper. Other estimates are lower – global investment researcher Morningstar puts average active fees at 0.78% and average passive fees at 0.18%.
Investors have voted with their feet and piled into passive investments – which have grown by 230% globally since 2007 to $6tr, according to Morningstar. This was four times the growth rate of assets held in active funds, which are still dominant.
The other anomaly is that over time, low-cost actively run funds have a much greater chance of beating benchmark indices than their more expensive peers, and also survive longer than the highest-cost funds.
Fund managers insist that during a time of low returns and high volatility, investing with managers that have a demonstrable track record of successful asset allocation will become even more important.
They do have a case – research has shown that low-cost actively managed funds in mid-cap and small-cap value, along with emerging markets (EM) – have a better success rate against passive peers.
According to Morningstar, close to two-thirds of active diversified EM funds outperformed their passive counterparts over the one- and three-year periods, which ended on 30 June 2016, while just over 55% performed over five years. In the longer term less than one-third of those funds outperformed – but while 60% of the lowest-cost actively managed diversified EM funds outperformed their index fund counterparts over the 10-year period, less than 12% of the highest-cost funds in that category did.
Investors of all risk profiles with investment horizons of 10 years or more stand a better chance of meeting their investment objectives merely by reducing the fees that they pay.
“Fees matter – they are one of the only reliable predictors of success,” the Morningstar report said.
A blended approach
The shift to using a mix of passive and active funds is well under way in the US, but many South African retail investors continue to invest in actively managed balanced funds offered by local unit trust companies.
Sanlam, Nedgroup Investments and Old Mutual are among the asset managers that have started to use a blend of passive and actively managed funds, and a handful of financial advisers are constructing portfolios in step with the trend.
“We do not believe that this is an argument which people need to take sides on,” says Craig Gradidge, a financial planner and founder at Gradidge-Mahura Investments. “We have been doing it since 2009.”
According to a survey last year by E-trade Financial Corporation, about 60% of experienced investors in the US say they prefer portfolios that combine passive and active management, with a passive approach in broad market areas and active management in narrower, less efficient market segments.
About 30% favour a purely passive approach while just 8% preferred a completely active one.
And a growing number of savvy funds and financial managers has begun to follow Vanguard’s lead of blending passive investing, active investing, and “smart beta” investing – which means using strategy indices constructed to earn returns from different types of “factor” risk – growth, momentum, value, or volatility. Around $500bn has been invested in “smart beta” strategies globally, up from just $50bn five years ago.
“We believe there is space for passive investing, smart beta, and fundamental active investing,” Old Mutual Investment Group said in a research note on the 2017 investment outlook.
“A blended combination of these three approaches should deliver the best risk-adjusted returns for clients.”
Blending not only offers lower costs, but creates greater certainty of outcome by reducing reliance on active managers delivering on their objectives, while allowing for allocations to “higher conviction” fundamental managers, it added.
Vanguard recommends building a core portfolio of index-tracking funds while adding carefully selected actively managed satellite funds or specialist index funds, which can complement the core and provide the potential for higher returns.
Adding technology to the mix
Blackrock, the world’s largest asset manager, has a different approach. It suggests that investors should think of active funds as long-term, core holdings and look for those with “broad mandates” and asset classes that are difficult to represent with an index.
Passive funds should be considered to achieve precise, tactical exposure to certain asset classes in a cost-effective and tax-efficient manner, it says. Rather than switching from one style to another as market or economic conditions change, adopting a long-term, strategic framework blending active and passive assets is more productive, it advises.
“I think everyone will have an individual approach based on their different levels of investment and education, but blended strategies work quite well,” says Mark Lindheim, chief investment officer for Investment Solutions.
A new type of development manager for the beta approach is evolving, who would use mathematical modelling on computers to sift through a large amount of data to construct portfolios, as opposed to more traditional stock-picking, Lindheim notes.
But he adds that technology could not yet match human ability to follow the psychology of market behaviour, and factor in sentiment and perceptions which were not driven by fundamentals.
“The best approach is to blend large data-crunching and overlay it with human intervention – we are moving to an age where there are more technology-based investment decisions.”
What this means is that financial advisers are starting to work side-by-side with machines, as they already do in manufacturing and service industries.
“Solutions is the buzzword – people don’t want a product, they want to solve a problem. There is less chance of doing that with one tool than with many,” he says.
Which ETFs look attractive?
The booming global appetite for exchange-traded funds (ETFs), which are similar to other index-tracking funds but are traded throughout the day like a share, has been reflected on the JSE. About 80 are now listed on the bourse.
Nerina Visser, strategist at etfSA, says she is still in favour of rand hedge investments with less exposure to South Africa, because of the country’s poor growth outlook and political uncertainty.
Figures released on 7 March showed that the economy contracted in the fourth quarter of last year, indicating that growth slowed to 0.3% in 2016 – the slowest pace since the recession in 2009.
This means that forecasts for this year are likely to fall below expectations, and credit rating downgrades to junk status later in 2017 are inevitable, which will put pressure on the rand.
Visser’s ETF picks for the year include the Satrix Indi 25, an ETF with a 70% exposure to markets outside of SA, which has clocked up annual average growth in returns of about 16% over the past 10 years. The biggest weighting within the fund is global internet and entertainment group Naspers* – also recommended by traditional stock-pickers, largely due to its 34% holding in Tencent, a leading provider of internet value-added services in China.
Visser also favours Deutsche Bank’s MSCI China Exchange Traded Note, which has returned an average of 15.37% over each of the past five years. Visser explains that her positive view on the Chinese environment is not based on the country’s growth outlook, but because it is loosening up its restrictions to foreign investors and its representation on global equity indices and portfolios is well behind its economic muscle.
The Core Shares S&P Top 50 is another ETF that Visser expects to do well because of its status as a direct US investment.
Swimming against the stream
Back in the world of traditional investing, Adrian Saville, chief strategist at Citadel, has somewhat contrarian views.
He recommends that local investors focus more on mid- and small-cap companies, which he believes are relatively under-researched and unknown in SA despite the fact that many are well-run and have strong balance sheets.
*finweek is a publication of Media24, a subsidiary of Naspers.
This cover story originally appeared in the 16 March edition of finweek. Buy and download the magazine here.
