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THE NEW WORLD ORDER INVESTMENT OUTLOOK 2019 INVESTMENT GROUP
UPFRONT
01 Message from Khaya Gobodo 04 About the authors
02 Executive summary
2019 INVESTMENT OUTLOOK
FEATURES
06 The four things to consider when 34 Red China is the world's new green leader?
investing in 2019 JON DUNCAN, HEAD OF RESPONSIBLE INVESTMENT
HYWEL GEORGE, DIRECTOR OF INVESTMENTS
38 Living annuities to come under pressure in
10 On the fast track below-average return environment
FRANK SIBIYA, PORTFOLIO MANAGER BRIAN VAMBE, INVESTMENT PROFESSIONAL AT MARRIOTT
14 Should you be selling listed property? 42 ood security adds to the investment
F
EVAN ROBINS, PORTFOLIO MANAGER appeal of global agriculture
CHRIS POTGIETER, HEAD OF OLD MUTUAL WEALTH
18
What could drive a bout of bullish yield PRIVATE CLIENT SECURITIES, TREASURY & FIDUCIARY
curve flattening in the new year?
WIKUS FURSTENBERG, PORTFOLIO MANAGER 46 Life coaching for wealth clients
AND HEAD OF INTEREST RATE PROCESS KERRIN LAND, MANAGING DIRECTOR OF
OLD MUTUAL WEALTH
22 2019: Boom, bust & supercycle revival or
something new? 48
How millennials are changing the future of
IAN WOODLEY, PORTFOLIO MANAGER financial services
ELIZE BOTHA, MANAGING DIRECTOR OF
OLD MUTUAL UNIT TRUSTS
26 ESG becomes a private equity priority
PAUL BOYNTON, MANAGING DIRECTOR OF
OLD MUTUAL ALTERNATIVE INVESTMENTS
30 Water is the new oil
THEO VAN DER VEEN & HANNAH YOUNG, UFF AFRICAN
AGRI INVESTMENTS
MESSAGE FROM THE MD 1
As investment managers, we have an opportunity to make a real difference in people’s lives.
We need to constantly be aware of the responsibility placed on us by those South Africans
entrusting us with their wealth and savings.
Most of these savings are customers’ investor confidence – a key ingredient for
primary source of income after retirement an economic recovery.
or their only safety net for an emergency.
A recovery and the stabilisation of markets
As such, we need to bring our skills to
will take time and our clients need to steel
bear in identifying and interpreting the
themselves for further short-term volatility.
impact of long-term socio-economic,
However, as is evidenced by our extensive
technological and political shifts that are
research into the long-term performance of
taking place globally and locally – and
asset classes, the stock market will inevitably
determining how these will impact the
experience periods of underperformance.
investment environment.
Over time, however, stock market returns
While keeping our focus on long-term become less volatile and, as history has
outcomes, we need to navigate the shown, continue to offer the best way to
short term. With this in mind, I grow your wealth over the long term, so
know it has been a particularly remaining invested through the volatility is
challenging year for investors, key to achieving our investment goals.
with 2018 on track to being
The range of topics covered in this
the most volatile year in
Investment Outlook for 2019 highlights the
the stock market since the
diverse issues our investment professionals
crash of 2008.
grapple with daily, especially as it relates
The local market volatility, to the key long-term issues we should all
coupled with a low consider. While we are not able to predict
growth environment, what will happen in the year ahead, this
political uncertainty publication does raise the questions that
and a deteriorating you need to be asking in 2019 and beyond.
economic outlook, is
To deliver on these priorities, it is important
unlikely to change
that we understand our environment, the
in the short term as
short- and long-term impacts of events and
we head into the
how we can best interpret these to deliver
national elections
the optimal outcome for our customers.
in 2019. We remain
That is what this publication is about.
hopeful that, post
what will be a Enjoy the read!
pivotal election,
we see greater Regards
policy certainly and KHAYA GOBODO
a resultant boost MANAGING DIRECTOR:
in business and OLD MUTUAL WEALTH & INVESTMENTS
2 EXECUTIVE SUMMARY
4 THINGS TO CONSIDER line with low-risk cash over the
WHEN INVESTING IN 2019 five-year period. Conditions
Investment success in 2019 for property companies are
will primarily depend on currently very difficult, but it’s
four factors: managing the not all bad news and investors
fee load on investors by shouldn’t be too quick to
including passive investments dismiss the sector.
in a portfolio mix; tapping
LIFE COACHING FOR
alternative assets for market- WEALTH CLIENTS
beating long-term returns,
At a time when social
benefiting from integrating
responsibility seems to be
ESG into everything we do and
growing and the wealthy are
ensuring that we harness the
looking at leaving a legacy that
power of artificial intelligence.
goes beyond their families to
ON THE FAST TRACK include their communities,
countries and the world, using
Due to four main drivers –
a life coaching approach to
regulations, performance
help high income clients
pressures, media and
manage their wealth has never
research advances, as well as
been more relevant.
technological progress – index
investing has experienced CLOUDS SET TO LIFT ON
monumental popularity in the FISCAL CONSOLIDATION
In anticipation of interest
INVESTMENT OUTLOOK 2019
rates rising, the market has
EXECUTIVE
already priced in a bearish
yield curve flattening where
short-term bond yields rise
faster than those at the
long end. This means the
SUMMARY
focus now shifts to the next
significant bond market
yield curve adjustment, likely
to be a bullish yield curve
flattening. The potential
drivers of this shift include the
clouds lifting on SA’s fiscal
past three to five years. And consolidation, US Treasury
with unrelenting innovations in market yields approaching
factor investing, ESG-focused our fair value estimate,
indices and multi-asset class the rand depreciating to
index investing, its growth is an oversold level, a strong
expected to continue. disinflationary backdrop
and reduced foreign investor
SHOULD YOU BE SELLING
holdings of SA government
LISTED PROPERTY?
bonds.
This perennial top performing
asset class was one of the worst THE NEW NORMAL FOR
performing asset classes over THE RESOURCES SECTOR
a three-year period to the end If the global economy avoids
of September 2018 and has a downturn, decent ongoing
only been able to perform in demand growth will mean that
OLD MUTUAL INVESTMENT GROUP
EXECUTIVE SUMMARY 3
prices for most commodities shrouded by the short-term,
will have to increase to induce very raucous noise?
new capacity to be built,
providing the mining houses DO WE NEED TO
with a nice boost to the
REWRITE THE BOOK FOR
MILLENNIALS?
bottom line.
Millennials are driving the new
ESG BECOMES A PRIVATE world order and the financial
EQUITY PRIORITY services sector will be no
More and more private equity exception, as millennials view
managers, particularly in Africa, their money and investments
are putting environmental, as powerful tools for changing
social and governance (ESG) the world. Financial services
factors centre stage in their providers will have to shift
investment decision-making their approach and mindset to
because these factors can and tap into this rapidly emerging
do make a tangible difference. youth market – but not at the
As these are mostly closed- expense of their other clients.
ended funds with a limited
number of investments,
FOOD SECURITY ADDS
TO THE INVESTMENT
the fund manager has real
APPEAL OF GLOBAL
scope for influence. As well AGRICULTURE
as a tool to mitigate risk and
The world is facing a growing
provide downside protection,
shortage of food supply
managers are increasingly
primarily due to declining
embracing the upside
arable land and a water
potential of investing in
shortage. Other factors,
sustainable businesses.
such as the reduction of
WATER IS THE NEW OIL waste and the application
of smart technologies to
Without rapid and practical
improve productivity, present
action, the effects of climate
opportunities to address
change will quickly translate
some of this shortfall. All of
into catastrophic water
these present a growing and
insecurity – and agricultural
an attractive investment
operations are extremely
opportunity.
vulnerable to water-related
risk. It is essential that African LIVING ANNUITIES TO
leaders, governments and TAKE STRAIN
institutions collaborate
A drawdown rate of 6% in
efficiently to achieve better
retirement is common in the
water management in the
market place but Marriott’s
current resource-scarce world.
research shows that, at that
RED CHINA IS THE rate, almost half of retirees
WORLD’S NEW GREEN would have depleted their
LEADER? capital within 30 years. This
Will sensible ideas about green suggests many living annuities
growth find a political voice in will come under pressure in the
both the Eastern, particularly years ahead – and that retirees
China, and Western economies will have to be particularly
in 2019 or will this important careful in how much income
set of long-term signals remain they draw.
Credit: Adrian Trinkaus
THE NEW WORLD ORDER 2019
4 ABOUT THE AUTHORS
ABOUT THE
AUTHORS
THE FOUR THINGS WHAT COULD DRIVE A
TO CONSIDER WHEN BOUT OF BULLISH YIELD
INVESTING IN 2019 CURVE FLATTENING IN
HYWEL GEORGE, DIRECTOR OF THE NEW YEAR?
INVESTMENTS WIKUS FURSTENBERG,
Hywel is responsible for delivering investment PORTFOLIO MANAGER AND HEAD
performance across our listed asset OF INTEREST RATE PROCESS
management boutiques as well as nurturing Wikus manages a range of institutional and
and developing new investment products. retail fixed income portfolios at Futuregrowth
His experience spans 30 years in leading Asset Management, which include income,
global institutional and private client asset core bond and flexible interest rate funds. He
management companies in Europe and the also heads up the Futuregrowth Interest Rate
Middle East. team.
ON THE FAST TRACK 2019: BOOM, BUST &
FRANK SIBIYA, PORTFOLIO SUPERCYCLE REVIVAL OR
MANAGER SOMETHING NEW?
Frank is responsible for managing local IAN WOODLEY, PORTFOLIO
and international tracker funds within the
MANAGER
Customised Solutions team, which manages
A multi-award winning portfolio manager,
over R92 billion in their indexation capability.
Ian joined Old Mutual Equities in 2011 and is
He specialises in index investing in Africa
responsible for assessing the diversified mining
and the emerging markets and has a strong
companies and non-mining companies such
background in mathematics and statistics.
as steel, forestry and paper. He is also the
portfolio manager for the Old Mutual Mining
and Resources Fund (unit trust).
SHOULD YOU BE SELLING
LISTED PROPERTY?
EVAN ROBINS, PORTFOLIO ESG BECOMES A PRIVATE
MANAGER EQUITY PRIORITY
Evan manages Old Mutual’s institutional and PAUL BOYNTON, MANAGING
unit trust SA Quoted Property portfolios. He
DIRECTOR OF OLD MUTUAL
joined the MacroSolutions boutique in 2012
ALTERNATIVE INVESTMENTS
as the property portfolio manager and has
Paul has been heading up Old Mutual
experience in a wide range of roles in the asset
Alternative Investments, one of the largest
management industry, particularly in equity
private alternative investment managers in
research, portfolio management and strategy.
Africa, since 2004. Having joined Old Mutual
in 1995, his entire career has been involved in
investment and capital markets.
OLD MUTUAL INVESTMENT GROUP
ABOUT THE AUTHORS 5
WATER IS THE NEW OIL FOOD SECURITY ADDS TO
THEO VAN DER VEEN & HANNAH THE INVESTMENT APPEAL
YOUNG, UFF AFRICAN AGRI OF GLOBAL AGRICULTURE
INVESTMENTS CHRIS POTGIETER, HEAD OF
Theo has been in the fresh produce trading OLD MUTUAL WEALTH PRIVATE
and distribution global industry since 1984. CLIENT SECURITIES, TREASURY &
At UFF he is responsible for relationship FIDUCIARY
management with agricultural operators and Chris leads an experienced team with a strong
their clients. track record of success to provide and manage
Hannah is a qualified environmental lawyer bespoke investment portfolios for private
who has been engaged with environmental clients, trusts, companies and pension funds.
and social issues across the African continent In his esteemed career, Chris has fulfilled
for more than 10 years. She is UFF’s ESG lead, senior and diverse roles within a number of
responsible for the ESG goals and performance investment businesses.
of the individual farms and funds.
LIFE COACHING FOR
WEALTH CLIENTS
RED CHINA IS THE KERRIN LAND, MANAGING
WORLD'S NEW GREEN DIRECTOR OF OLD MUTUAL
LEADER? WEALTH
JON DUNCAN, HEAD OF Kerrin’s team implement planning tools and
RESPONSIBLE INVESTMENT industry leading solutions to assist financial
With over 20 years’ experience in the field of planners in guiding their clients on their
sustainability research and engagement, Jon wealth journey. She previously spent 20 years
leads the Responsible Investment programme with Old Mutual Investment Group, where she
at Old Mutual. His focus is on driving the held various technical and leadership roles
systemic integration of material ESG issues and played a key role in developing some of its
across Old Mutual. most innovative offerings.
LIVING ANNUITIES TO HOW MILLENNIALS ARE
COME UNDER PRESSURE CHANGING THE FUTURE
IN BELOW-AVERAGE OF FINANCIAL SERVICES
RETURN ENVIRONMENT ELIZE BOTHA, MANAGING
BRIAN VAMBE, INVESTMENT DIRECTOR OF OLD MUTUAL UNIT
PROFESSIONAL AT MARRIOTT TRUSTS
Brian is responsible for both primary and Elize and her team assist retail investors
secondary research in the securities market, in preserving and growing their wealth.
as well as monitoring broad macro-economic This includes partnering with Old Mutual
variables. He has successfully completed Investment Group to ensure a strong specialist
his level 1 CFA exam and is a member of the investment capability, as well as providing
Investment Analysts Society of Southern Africa. clients with the best possible service.
THE NEW WORLD ORDER 2019
6 INVESTING IN 2019
FOUR BIG
THINGS TO
CONSIDER
WHEN
INVESTING
IN 2019
“It is much easier after the event to sort the relevant from the irrelevant signals. After the event, of
course, a signal is always crystal clear.” – Nate Silver, The Signal and the Noise. Identifying the relevant
signals from the noise has been key to successful investing in 2018, and will be again in 2019.
T
hat is a fundamental part of our job However, with markets having been strong,
as professional investment managers. assets under management in active funds have
Actively helping our clients do the same also grown (see Figure 2) and we believe there
WRITTEN BY
in their role is also fundamental to our is still a place for active investing to make up
HYWEL GEORGE,
D I R E C TO R O F industry; striking a true partnership a decent component of the mix in a portfolio.
INVESTMENTS between asset owners, their consultants and asset Passive investing (i.e. tracking an index) comes
managers is the sensible way forward. with its own risks and to outperform under
certain market conditions, history has shown
As such, we humbly offer four thoughts that
the benefits of fundamental active investing. For
we believe asset owners should be applying
instance, with just seven stocks making up 50%
themselves in 2019:
of the JSE, that level of concentration, should
01/ HAVE SOME PASSIVE things turn, would be a big risk. Active managers
IN THE MIX can help navigate this.
Passive investing continues to gain support Thus a win-win situation would be a
and will remain an important part of the combination of the two, leading to better
investment landscape going forward. As Figure 1 outcomes for investors, because the passive
shows, within US equity investments, almost investments would enable investors to manage
US$1 trillion has flowed into passive funds, while their fee load while the stockpicking of active
US$1 trillion has flowed out of active investing – managers should continue to add value relative
that’s a US$2 trillion swing in investment flows. to the market.
OLD MUTUAL INVESTMENT GROUP
INVESTING IN 2019 7
FIGURE 1: GROWTH OF PASSIVE – DOMESTIC US EQUITY CUMULATIVE
FLOWS ($BN)
1000
894
800
400
0
-400
-800 Passive
-836
Active
-1000
Aug 07
Feb 08
Aug 08
Feb 09
Aug 09
Feb 10
Aug 10
Feb 11
Aug 11
Feb 12
Aug 12
Feb 13
Aug 13
Feb 14
Aug 14
Feb 15
Aug 15
Feb 16
Aug 16
Sources: Old Mutual Investment Group; Morgan Stanley Research
FIGURE 2: ACTIVE STILL GROWING – GLOBAL ASSETS UNDER MANAGEMENT
(IN US$ TOTAL RETURN)
35
31
30
29 29
27
25 23 ACTIVE +31%
Credit: Bud Helisson
20 20
20 18 25
02/ LOOK FOR RETURNS 24 23
ELSEWHERE 15
20 22
During 2019, investors will also need to keep 17 17
adding real, alternative sources of return outside 10 16
of plain vanilla equity and bond portfolios. These
would be real assets, including infrastructure 5 PASSIVE +202%
6 7
investments, real estate and agriculture, which 5
3 3 4 4
are popular globally, as well as private equity 2
0
and hedge funds. Figure 3 shows the growth in 2009 2010 2011 2012 2013 2014 2015 2016 Q3
global assets under management invested in
these alternative assets. Source: McKinsey Performance Lens Global Growth Cube
Global research into institutional investor
perceptions of alternative assets shows FIGURE 3: ALTERNATIVE SOLUTIONS
that hedge fund returns have disappointed OF RETURN – GLOBAL AUM OF KEY 7.3
ALTERNATIVE ASSET CLASSES
investors, Figure 4 on the following page
showing that with 64% of investors unhappy 6.2
with their hedge fund returns. However, 71% 2.7
5.2
of the investors were happy with the returns 2.1
delivered by their private equity investments. One 1.7
needs to be judicious, however, in one’s choices 3.2 1.8
of these alternative assets. 2.1
1.0 1.6
Overseas more than a third of the assets of the
100 largest pension funds are now invested 1.1
2.9
in alternative assets in some form or another, 1.9 2.0
whereas in SA alternative investments comprise 1.1
a mere 2% of institutional assets. So we have 2005 2007 2011 2015
a lot of work to do to increase that exposure
Hedge fund Private equity Real assets
locally to give investors exposure to the long-
term, premium real returns they can offer.
Sources: McKinsey Performance Lens Global Growth Cube, Preqin; HFR; McKinsey Private Equity database
THE NEW WORLD ORDER 2019
8 INVESTING IN 2019
FIGURE 4: GLOBAL AUM OF KEY ALTERNATIVE ASSET CLASSES – INSTITUTIONAL 03/ INTEGRATE ESG INTO
INVESTOR PERCEPTIONS OF ALTERNATIVE ASSET CLASSES, 2013-16 EVERYTHING YOU DO
People’s perceptions are shifting, with many
HEDGE FUNDS (%) PRIVATE EQUITY (%) becoming more mindful of sustainable
5
investing. In fact, a 2017 Schroders Investment
16 11 8 6
Study showed that 78% of respondents said
35 33
that sustainable investing has become more
64 important to them in the past five years.
44 73
75 With some US$80 trillion global assets under
63 78
management, the investment industry has the
57 58
greatest potential to influence decisions and
practices relating to sustainability. Figure 5 shows
30 that inflows into ESG funds have taken off, with
30
21 24
13 17 an almost exponential rise in flows over the past
8 9 3
few years.
2013 2014 2015 2016 2013 2014 2015 2016
Fallen short of expectations Met expectations Exceeded expectations
The decision to invest in funds that have a clear
preference for those companies that focus on
Source: https://www.msci.com/end-of-day-data-search positive environmental, social and governance
principles is made easier by the fact that there
appears to be no trade-off between making
FIGURE 5: GLOBAL FLOWS INTO ESG FUNDS ARE GAINING MOMENTUM – sustainability an investment priority and
INVESTMENT FUNDS INCORPORATING ESG FACTORS 1995-2016 achieving competitive returns. Figure 6 shows
that investing in a global ESG strategy would
3000 1200
have added significant alpha over time.
2500 1000 This makes intuitive sense because integrating
TOTAL NET ASSETS (US BILLIONS)
ESG into investment decisions means you
NUMBER OF FUNDS
2000 800 generally invest in quality companies that make
better long-term decisions and thus deliver more
1500 600 sustainable returns over time.
This is particularly true in emerging markets and
1000 400
South Africa where the quality of a company
is often informed by standards of corporate
500 200
governance and other ESG considerations that
affect a company’s ability to deliver in the long term.
0 0
This is evident in the outperformance of an MSCI
Number of Funds Total Net Assets (US billions)
EM ESG Index versus an MSCI EM Index (see
Source: US SIF Foundation
Figure 7) and in South Africa where an ESG version
FIGURE 6: ESG STRATEGY WOULD HAVE DRIVEN 18% EXCESS ALPHA –
RELATIVE PERFORMANCE: HIGH THIRD VS LOW THIRD BY ESG SCORE
140 AS OF 10/31/16
130
120
110
100
90
80
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Environmental Overall Social Corp. Governance
Source: Thomson Reuters, BofA ML US Equity & Quant Strategy
OLD MUTUAL INVESTMENT GROUPINVESTING IN 2019 9
the way we work and conduct ourselves in all
250
FIGURE 7: MSCI EMERGING MARKETS VS MSCI EMERGING MARKETS aspects of our lives over the coming decade.
ESG LEADERS(US$) TO END SEPTEMBER 2018
MSCI EMERGING ESG LEADERS MSCI EMERGING MARKETS From an investment perspective, the way
200 asset managers integrate AI into the way they
manage money is likely to be fundamental to
their future success. As such, one of our biggest
PRICE INDEXED
150 work streams in 2018 (and into 2019) has been
focused on embedding AI into everything we
do as an asset manager.
100
There’s no doubt AI is a new toolbox and it will
facilitate greater productivity and insight from
humans. We don’t believe it will be a case of
50 machine-only, but expect the winners to be
those who optimise the relationship between
human and machine.
0
It is an exciting time and we are focused on
Sep 07
Mar 08
Sep 08
Mar 09
Sep 09
Mar 10
Sep 10
Mar 11
Sep 11
Mar 12
Sep 12
Mar 13
Sep 13
Mar 14
Sep 14
Mar 15
Sep 15
Mar 16
Sep 16
Mar 17
Sep 17
Mar 18
Sep 18
five key areas where AI will directly impact
Source: https://www.msci.com/end-of-day-data-search the way we manage our clients’ assets:
1. The
data asset managers need to source
FIGURE 8: SA ESG CUMULATIVE RETURNS VS JSE SWIX will evolve from the current news scrapes,
management emotion measures and
TO END SEP 2018
240 satellite imagery, and our ability to clean
and curate that data will be key.
220
2. AI will help asset managers interpret that
200
data and look for themes, or indicators
180 that uncover new ideas.
160
3. I will help asset managers design better
A
stock and sector filter screens to identify
140
those companies that have attractive
120 investment characteristics.
100
4. AI will help with portfolio construction
Sep 12
Mar 13
Sep 13
Mar 14
Sep 14
Mar 15
Sep 15
Mar 16
Sep 16
Mar 17
Sep 17
Mar 18
Sep 18
and risk management, helping identify
risk clusters that were previously hidden.
Responsible Investment Equity Index Fund ALSI SWIX - Parent Index
5. I will help in stock-specific fundamental
A
Source: Old Mutual Customised Solutions
research, finding anomalies that beg
questions, and helping dig into issues
of the JSE SWIX Index added alpha over the past
"
that highlight the need to gather more
five years (see Figure 8).
information.
This is not just about investing in those
WITH SOME In essence, it will come down to how an asset
companies that meet the ESG criteria as set out
by the index, but requires the asset managers’ US $80 TRILLION manager uses the data to search for those
ongoing commitment to challenge companies GLOBAL hidden themes that add value to a portfolio
and lead to more consistent outcomes for
to make the best long-term decisions to better ASSETS UNDER clients.
comply with ESG principles. This confirms that
MANAGEMENT,
by investing in the right way, asset managers can
have a positive impact on communities and the THE INVESTMENT THE BOTTOM LINE
environment, while also delivering alpha (returns INDUSTRY HAS We believe that investment success in 2019
will partly depend on the above four factors.
in excess of their benchmark). THE GREATEST One can manage the fee load on investors by
04/ UNDERSTAND AND POTENTIAL TO including passive investments in a portfolio
INTEGRATE ARTIFICIAL INFLUENCE mix, tap alternative assets for market-beating
INTELLIGENCE INTO DECISIONS AND long-term returns, benefit from integrating
INVESTMENT DECISIONS PRACTICES
ESG into everything we do, and ensure that we
harness the power of artificial intelligence.
While there may be some scepticism as to the RELATING TO
extent that artificial intelligence (AI) will change
SUSTAINABILITY.
"
our day-to-day lives, it could well turn out to have
the most profound and fundamental impact on
THE NEW WORLD ORDER 201910 ON THE FAST TRACK
ON THE
FAST
TRACK
We look at the evolution of
passive investing – which we
term as indexation – over the
past decade and assess whether
its exceptional growth over the
last three years is expected to
continue.
WRITTEN BY
F R A N K S I B I YA ,
PORTFOLIO
MANAGER
Credit: Gaelle Marcel
OLD MUTUAL INVESTMENT GROUPON THE FAST TRACK 11
■■ Greater transparency – a greater need to
FIGURE 9: 10-YEAR GROWTH IN INDEX INVESTMENT STRATEGIES
understand the drivers of risk in an investment
(ASISA SA GENERAL EQUITY AND LARGE CAP EQUITY)
strategy
800%
■■ Cost efficiency – ensuring that the costs
700%
are justified by the level of value-add being
600%
generated by the asset manager
500%
■■ Consistency – strategies that deliver
400%
consistent performance, especially relative to a
300%
predefined benchmark.
200%
100%
MEDIA AND RESEARCH
0% We live in a world in which Warren Buffet has
publicly backed index investing (see the sidebar
-100%
titled “A Million-Dollar Bet”). And research
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is continually demystifying and re-defining
the source of alpha (see Figure 10). Now, with
Index Investment Strategies Actively Managed Strategies
growing emphasis being placed on factor
I
Sources: Old Mutual Customised Solutions; Morningstar research and evidencing of how alpha is
expected to be diminished, this all translates into
n the South African retail market indexation growing publicity and popularity for indexation.
investment strategies have grown by 46%
p.a. over the last 10 years (see Figure 9). Is this TECHNOLOGY
"
growth likely to be sustained during 2019 In today’s world technology has made the
and what innovative developments can be dissemination of information close to instant,
expected in the passive investment segment of TECHNOLOGY IS which makes it difficult to generate excess
the market going forward? ALSO PLAYING A returns as before. Technology is also playing a
01 / PASSIVE AGGRESSIVE: CRITICAL ROLE critical role in reducing costs across multiple
industries, and investors expect this trend
WHY INDEXATION IS SO IN REDUCING to apply to the investment industry as well.
POPULAR COSTS ACROSS Indexation strategies have become particularly
Spurred by an increasing acknowledgement of MULTIPLE ideal vehicles to use in computer-generated
portfolios and advances in technology have
the long-term benefits of low-cost solutions, the INDUSTRIES.
"
take-up of indexation is expected to continue allowed for large-scale customisation in
growing at a healthy clip. This increased uptake exchange traded funds (ETFs) that satisfies
can be attributed to the following factors: desired investment outcomes.
THE REGULATORY ENVIRONMENT
The Global Financial Crisis (2008) acted as a
FIGURE 10: THE MORPHING STATE OF ALPHA
catalyst for additional regulatory intervention;
regulatory bodies have since then been
pressuring the investment industry to be more Source of Fama Mark Robert
Return Unknown CAPM & French Carhart Novy-Marx
cognisant of investment risks. Examples of
Alpha
ALTERNATIVE
this have been Basel 3 and SAM (i.e. Solvency Alpha & EQUITIES:
ADAPTIVE
Assessment and Management), which BIASES
Value
placed greater focus on transparency and risk Alpha Value size
size momentum EQUITIES:
management in the banking and insurance momentum quality CONSISTENT
Value BIASES
industries. Within the South African investment size
context the Retail Distribution Review and SMART BETA
Portfolio
the Savings Default Regulation have both return
highlighted the importance of investors being
charged fair and transparent costs. Bulk Bulk Bulk Bulk
BETA BETA BETA BETA INDEXATION
INVESTOR PERFORMANCE PRESSURES.
There has been growing concern about
investment strategies not adding enough value
1966 1992 1997 2012
relative to their costs. This concern has been Prior to
1966
fuelled by investors being exposed to expensive,
complex investment structures, many of which
have failed to add value over the long term. As a Sources: Eugene Fama and Kenneth French, The Cross Section of Expected Stock Returns, Journal of Finance, June 1992; Mark
Carhart, On Persistence of Mutual Fund Performance, Journal of Finance, March 1997; Robert Novy-Marx, The Other Side of Value:
result, investors have increasingly prioritised: The Gross Profitability Premium, Journal of Financial Economics, April 2013.
THE NEW WORLD ORDER 201912 ON THE FAST TRACK
02/ WHERE TO FROM
A MILLION- HERE
DOLLAR BET
The pressures detailed above have supported
In 2007, legendary the growth in index investing. And we expect
investor Warren the following innovations to fuel continued
Buffett made a US$1 million growth in this area:
bet against Protégé
Partners that hedge FACTOR INVESTING
funds wouldn't
outperform an S&P index Globally, there has been an increase in the
fund. Buffet won. number of solutions that follow low-cost
investing strategies, such as smart beta.
Buffett's choice fund, the
According to Morningstar, smart beta assets
Vanguard 500 Index Fund
Admiral Shares, returned under management globally grew from
7.1% compounded US$280 billion in 2012 to US$999 billion at the
annually, while the end of 2017 – a total increase of 257% over the
basket of hedge funds five-year period. We expect this trend to pick
his competitor chose up in the South African industry. This would
returned an average of
appeal to investors who do not desire using
only 2.2%.
market cap weighted indices but would still
Buffett and Protégé like to benefit from the reduction in costs.
Partners originally put
about US$320,000 each ESG INDICES
into bonds that would
appreciate to US$1 million
Broad acceptance of Responsible Investment
over the course of their practices in the market (over 1 200 asset
wager, but because the owners, investment managers and
bonds appreciated much professional service par billionaires have
faster than expected, become signatories of the United Nations-
they decided to buy
backed Principles for Responsible Investment
11 200 Berkshire B shares,
(PRI)) has translated into strong demand for
which are now worth
US$2.22 million. sustainability-themed investment products.
And innovation in the indexation investing
space in recent years has allowed index-
Source: Wall Street Journal, https://
www.wsj.com/articles/only-a-market-
tracking investment managers to incorporate
crash-can-stop-warren-buffett-from- ESG factors into their investment process. And
winning-this-1-million-bet-1487851203
so, the market now has on offer low-cost indices
FIGURE 11: EXISTING ALLOCATIONS TO SMART BETA
60%
46% 48%
40%
36%
32%
26%
20%
0%
2014 2015 2016 2017 2018
Source: FTSE Russell: Global Smart Beta Surveys of Asset Owners, 2014-2018
OLD MUTUAL INVESTMENT GROUPMESSAGE FROM THE MD 13
Credit: Joshua Ness
"
that offer ESG-led mandates and champion IT TAKES A MIXED BAG
Responsible Investment. As at December 2017, Today, it would be reasonable to say that
MSCI reported that about US$98 billion of assets BOTH ACTIVE the majority of the investment community
is benchmarked against the MSCI ESG indices. AND PASSIVE do not see indexation as merely a fad, but
MULTI-ASSET CLASS INDEX INVESTING STRATEGIES rather a useful investment strategy that can
Recent regulatory amendments, known as
HAVE A ROLE help investors achieve their goals. If you are
still not sure of this, just check out Figure 9
the retirement fund default regulations, have TO PLAY AND again. However, as passive/index investing
significant implications for South African PARTNERING grows more popular, we don’t think investors
investors. In terms of the regulations, retirement
WITH THE RIGHT should give up on active investing. Both active
funds will have to consider “cradle-to-grave” and passive strategies have a role to play and
investment goals; they need to assist members MANAGER
partnering with the right manager to find
during both the accumulation phase and the TO FIND THE the right balance between the two strategies
retirement phase of their investments in a cost- RIGHT BALANCE is key. Investors with a blend of both active
efficient manner, whereas previously they were
required to assist members only during the
BETWEEN THE and index investments have the opportunity
to both outperform the market index and
accumulation phase. In this context, low-cost life- TWO STRATEGIES reduce the risk that they will underperform
staging offerings are growing in importance. And IS KEY.
"
the market, all while reducing their total
using a multi-asset class fund is a highly efficient investment costs.
and robust solution.
THE NEW WORLD ORDER 201914 LISTED PROPERTY
MESSAGE FROM THE MD
SHOULD YOU
BE SELLING
LISTED
PROPERTY?
From hero to zero. Listed property has fallen from
grace. This perennial top performing asset class
was one of the worst performing asset classes
over a three-year period to the end of September
2018 and has only been able to perform in line
with low-risk cash over the five-year period (see
Figure 12). Given all this negative news, it is easy to
forget that over a longer period listed property still
comfortably remains one of the top performers.
Credit: Jan Romero
OLD MUTUAL INVESTMENT GROUPLISTED PROPERTY 15
D
oes this recent poor performance BOND YIELDS ARE NO LONGER LOW
mean you should run for the
Listed property yields tend to follow
hills in 2019? Not so fast… To get
government bond yields. If yields rise, prices fall.
some perspective, I look at what’s E VA N R O B I N S ,
PORTFOLIO MANAGER
A couple of years ago there was a substantial
improved and what hasn’t, and why
capital risk to listed property prices if global
investors should not be too quick to dismiss the
and South African bond yields were to rise from
property sector.
their then historic multiple-decade lows.
01/ WHAT HAS IMPROVED: Bond yields in the United States and in
SOME MAJOR CONCERNS South Africa have now risen significantly
HAVE DISSIPATED (see Figure 14 on the next page). Indeed, in
MacroSolutions we now believe that SA bonds
There are four key non-economic growth related
are cheap and yields are more likely to fall
concerns we explicitly cautioned clients about
than rise. Buying listed property now offers the
in the past that have now disappeared. In some
prospects of an opportunity for capital gain if
cases, they have even turned positive. This creates
yields fall, and less probability of a loss from
a more favourable valuation and structural
rising SA bond yields.
environment for the sector.
THE MARKET IS NO LONGER
THE EXTREME VALUATION OF THE UNREALISTICALLY SANGUINE
RESILIENT STABLE IS OVER
We were of the view that the SA market and
The companies in the Resilient stable, which
property companies were too backward
comprised over 40% of the listed property
looking, under-estimating the gravity of future
benchmark at the start of the year, were much too
economic and property deterioration.
expensive. Given their weight in the FTSE/JSE SA
Listed Property Index (SAPY), this posed significant Our sense is that the market and companies
sector risk if (and when) their prices normalised. are now cognisant of how difficult conditions
This occurred in early 2018 (Figure 13 on the are and the downside risks involved.
following page), and much more aggressively than Companies are reducing growth guidance and
we anticipated – contributing substantially to the make no secret of how difficult things really
current sector malaise. By way of comparison, are. Expectations now are more reasonable.
at the time of writing property heavyweight This does not mean conditions will be easier or
Growthpoint’s total return was down 7% over 2018. that they can’t get worse, nor does it mean that
By contrast, the SAPY benchmark index, which there won’t be nasty surprises.
has a heavy weighting to the Resilient stable, was
It just means that market expectations and
down 23%. Resilient stable companies’ share
pricing are now more realistically taking this into
prices roughly halved in value this year.
account. One of our preferred relative valuation
The Resilient stable’s share price overvaluation measures, the spread between SA REITs and the
concerns are now behind us. There could even be inflation-linked bonds, is now at a level last seen
upside if market concerns are alleviated. during the global financial crisis.
FIGURE 12: ASSET CLASS RETURNS: LISTED PROPERTY RANKS TOPS OVER THE LONG TERM
1-YEAR RETURNS to end of September RETURNS to end of September 2018
Sep 10 Sep 11 Sep 12 Sep 13 Sep 14 Sep 15 Sep 16 Sep 17 Sep 18 H1 2018 YTD 3–year 5–year 10–year 15–year
SA Real SA Real SA Real SA SA Real SA Real SA SA Real SA SA SA SA Real SA Real SA Real
SA Cash
Estate Estate Estate Equity Estate Estate Bonds Estate Cash Cash Bonds Estate Estate Estate
7.3%
24.6% 6.2% 32.6% 22.7% 14.9% 25.3% 7.5% 8.8% 3.6% 5.4% 7.6% 6.8% 12.0% 16.2%
SA SA SA SA Real SA SA SA SA SA SA SA SA SA SA SA
Equity Bonds Equity Estate Equity Cash Cash Cash Bonds Equity Bonds Cash Cash Equity Equity
17.2% 6.0% 19.9% 10.8% 13.9% 6.3% 7.2% 7.8% 5.9% 2.3% 4.8% 7.3% 6.8% 9.7% 14.7%
SA SA SA SA SA SA SA SA SA SA SA SA SA SA SA
Bonds Cash Bonds Cash Bonds Bonds Equity Bonds Equity Bonds Equity Equity Bonds Bonds Bonds
15.0% 5.7% 15.8% 5.1% 6.0% 6.1% 6.4% 6.9% 1.1% -3.0% -3.8% 6.7% 6.5% 8.1% 8.2%
SA SA SA SA SA SA SA Real SA SA Real SA Real SA Real SA Real SA SA SA
Cash Equity Cash Bonds Cash Equity Estate Equity Estate Estate Estate Estate Equity Cash Cash
7.2% 3.4% 5.5% 3.3% 5.5% 2.0% 2.7% 4.3% -13.5% -3.2% -22.2% -1.4% 5.4% 6.8% 7.3%
Source: FactSet. SA Equity represented by FTSE/JSE Shareholder Weighted All Share (SWIX) Index
THE NEW WORLD ORDER 201916 LISTED PROPERTY
LISTED PROPERTY YIELDS ARE HIGH
FIGURE 13: ANNUS HORRIBILIS − RESILIENT STABLE DRAGS THE SECTOR
Three years ago, we cautioned clients that a DOWN (THICK LINE)
forward yield of as low as 6% was very expensive.
10%
Today, at a forward yield approaching 10% for
the SAPY Index and SA REITs, the valuation 0%
TOTAL RETURNS ‒ INDEXED
environment is completely different: it’s cheap. -10%
Dividends can fall by a third and you will receive -20%
the same yield as was offered three years ago! -30%
Property yields were last at these levels during -40%
the global financial crisis. -50%
02/ WHAT ARE OUR -60%
CONCERNS? -70%
-80%
It’s “the economy, stupid”, as the saying goes. Jan Feb Mar Apr May Jun Jul Aug Sep Oct
Conditions for property companies are very 2018 2018
difficult and could deteriorate further. New NEPI Rockcastle Plc Resilient REIT Limited Fortress REIT Ltd Class B
rentals are often being signed at lower levels and Greenbay Properties Ltd. Fortress REIT Ltd Class A FTSE/JSE SA Listed Property (SAPY) Index
there is a strong possibility that vacancies may
Source: FactSet
increase. The longer it takes for conditions to
improve, the worse the damage. The economic
crisis affects all South African companies and
industries. In a poor environment, listed property FIGURE 14: ELEVATED SA GOVERNMENT BOND YIELDS, GOOD FOR
PROPERTY IF THEY FALL
should be more defensive than most other
domestic local equities. 11.0%
10.5%
Macroeconomic conditions aside, there are still
issues that worry us within the property sector. 10.0%
These include: 9.5%
9.0%
DIRECT PROPERTY VALUATIONS
8.5%
COULD FALL
8.0%
Considering the state of the economy and the
7.5%
level of bond yields, we are surprised that direct
7.0%
physical property capitalisation rates (a measure
6.5% South African Benchmark Bond – 10-Year Yield
used to value physical properties) have held up so
well. We would have expected cap rates to have 6.0%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
widened by 100 to 200 basis points (bps), which
"
Source: FactSet
WE WERE OF
FIGURE 15: VALUE? SA LISTED PROPERTY INDEX FORWARD YIELD
THE VIEW THAT
THE SA MARKET
AND PROPERTY
DIVIDEND YIELD (NEXT TWELVE MONTHS)
14%
COMPANIES 13%
WERE TOO 12%
BACKWARD
11%
10%
LOOKING, UNDER-
9%
ESTIMATING 8%
THE GRAVITY 7%
OF FUTURE 6%
ECONOMIC
FTSE/JSE SA Listed Property (SAPY) Index dividend yield (NTM)
5%
AND PROPERTY
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
DETERIORATION.
"
Source: FactSet
OLD MUTUAL INVESTMENT GROUPLISTED PROPERTY 17
implies buildings’ values fall by over 10%. If this ■■ Non-sustainable earnings growth drivers:
occurred, company net asset values (NAVs) There are deals that provide a one-off
would fall by more than this because balance boost to growth. This often dovetails with a OFFSHORE
sheets are geared. This will make loan-to-value flood of SA property companies investing INVESTMENTS:
ratios more stretched.
offshore (see box alongside). The problem EXAMPLES OF
There are mitigating factors. Unlike direct is not that the sustainable earnings base N O N - S U S TA I N A B L E
physical property, listed property prices have of the company is overstated, but that GROWTH DRIVERS
weakened and are trading below NAV, so the investors get distorted expectations of
listed market is priced for property values to fall. potential earnings growth. Eventually Most domestic property
The South African listed market, erroneously in companies have been
capacity to do these deals is exhausted.
our view, pays scant attention to NAVs, which aggressively investing
Investors may get a negative surprise when offshore to diversify away
means that a fall in direct valuation would have
companies are left “naked”, having to rely from a tough local economy,
a muted effect on prices. Most property funds’ look for other sources of
on scanty organic growth to drive earnings
gearing levels are not elevated, so if prices fall, growth and benefit from
sector gearing would move from a comfortable upwards. property yields well in excess
of funding costs (unlike in
level to the limits of the comfort zone. There are ■■ Negative surprises: In a difficult SA). Consequently, listed
always those companies who would be under property performance and
environment, every results season will see
great pressure. price today are less of a
some companies suffering unexpected
function of South African-
EXCESS PHYSICAL PROPERTY SUPPLY negative surprises – for instance, a major specific factors. A prolonged
IN A LOW DEMAND ENVIRONMENT tenant unexpectedly leaves or fails. While, strong rand could actually
in aggregate, this may only make a small be bad for the distribution
There is a structural over-supply of office and growth rate of domestic
retail property. This is not new news. Developers difference, it can result in materially poor
REITs with high offshore
and corporates are still building additional performance for the REIT concerned and exposure.
offices and shopping centres despite the sour general sentiment.
A consequence of the move
absence of incremental new demand from The concerns we delineated that have offshore, deliberate or not,
job creation or retail sales. If the economy was receded are predominantly structural or is often a one-off boost to
stronger this would be naturally absorbed, but valuational in nature. The concerns that earnings growth. Here are two
in this environment it pushes down rentals and scenarios to illustrate this:
remain are functions of our low growth
occupancies. The level of new development environment, which could get worse before - A
South African property
is slowing, but there is still an overhang from it gets better for property companies. If the company buys assets
projects in progress. overseas that yield 7% and
economy improves, these concerns dissipate.
it funds these entirely with
Shopping centres face additional challenges. Another important new concern is the debt at an offshore currency
Edcon is under grave pressure and most other rate of 3%. Immediately,
excessive gearing levels and currency and earnings will rise by 4%
nationals and line stores are facing flat or interest rate structures of many offshore (7% - 3%) times the value
declining sales per metre of shop floor. Rent-to- acquisitions. This has front-loaded growth of the acquisition. This can
sales ratios having deteriorated markedly. There and increased the risk of a nasty outcome be very material to that
is only so much low trading density growth the year’s earnings growth. The
if these investments or structures sour,
company will need to do
sector can absorb before there is a downward while also being distribution-detrimental to another deal of a bigger size
step change in the sector. It is still early days unwind. (These issues need a separate article next year to replicate that
in the generalised retail deterioration, but a to explain.) growth rate effect.
prolonged slowdown will be painful and novel
There are no easy catalysts for a recovery in - A
local company may have
for the sector. funded a past offshore
listed property, but the high return on offer acquisition with SA rand
LOW QUALITY EARNINGS, NON- provides a cushion. If general conditions debt at say 10%. If it swaps
SUSTAINABLE DRIVERS OF EARNINGS continue to deteriorate, domestic property is a this into foreign currency
GROWTH AND NEGATIVE SURPRISES value trap (cheap, but at risk of getting worse), denominated debt at
say 3%, the company can
but the property sector would not be alone.
■■ Low quality/inflated earnings base: reduce its interest costs
With their backs against the wall, some The economy and property are cyclical. The by 7% (10% - 3%) times
the value of the debt. A
management teams look for any source most money is made buying at cycle bottoms
major one-off reduction in
of income, no matter how fleeting. If these and selling at cycle tops. If investors were interest expenses leading
sources are depleted, earnings may need happy to hold property at a 6% forward yield, to an earnings boost, but
it is not obvious they should be in a hurry to sell less rand-hedge protection
to be rebased downwards, which is what as assets and liabilities are
at a 50% higher income return of over a 9%
some companies have already done. This now in the same currency.
yield. Bear markets can clear out some of the
is less of an issue than some believe as this
excesses created in the cycle highs. We have
type of income is not substantial. The risk
shown how some of this has occurred in the
here lies with the companies that have not property sector, creating a healthier backdrop
disclosed the extent of low-quality income for the recovery whenever that occurs.
they distribute.
THE NEW WORLD ORDER 201918 YIELD CURVE ADJUSTMENT
WHAT COULD
DRIVE A BOUT
OF BULLISH
YIELD CURVE
FLATTENING
IN THE NEW
YEAR?
WRITTEN BY
WIKUS FURSTENBERG,
PORTFOLIO MANAGER
AND HEAD OF INTEREST
R AT E P R O C E S S
Credit: Clem Onojeghuo
OLD MUTUAL INVESTMENT GROUPYIELD CURVE ADJUSTMENT 19
Following a rather protracted period during which political and
market events introduced some distortion to the interest rate
cycle, a level of “normality” returned by the end of 2017. What do
we mean by “normality”, you may ask? Simply put, the focus has
returned to growth and inflation drivers, as opposed to political
events, influencing monetary policy and the interest rate cycle.
C
onsidering all the FIGURE 16: THE INTEREST RATE CYCLE...
various drivers of WHAT IS THE NEXT BIG YIELD CURVE ADJUSTMENT?
the interest rate
cycle, our view of IS THIS THE NEXT
BIG YIELD CURVE
where we are at
ADJUSTMENT?
the time of writing (October
INFLATION PEAKS
2018) is indicated below (see Economic activity slows
Figure 16). However, of greater
importance is where we are
Bear flattening Bull flattening
heading and, more specifically,
how the yield curve will
behave.
01/ WHAT IS
THE NEXT BIG FIRST RATE HIKE FIRST RATE CUT
YIELD CURVE Rate of inflation
increase slows
Rate of inflation
ADJUSTMENT?
decrease slows
While it goes without saying
that financial markets never
move in an orderly fashion, it is Bear steepening Bull steepening
clear that the dominant yield
curve change over the past
year or two was for the yields
of longer-dated nominal
bonds to rise to higher levels,
INFLATION TROUGHS
while the yields at the short Economic activity
WE ARE HERE accelerates
end still tracked the repo
rate lower until as recently as
March 2018.
This is also known as bearish
yield curve steepening. With Bear Steepening: longer-dated bond yields rise Bull Flattening: longer-dated bond yields fall faster
inflation rearing its head and faster than yields at the short end (often happens than yields at the short end (lower inflation and the end
the South African Reserve when inflation is expected to rise). of the monetary policy tightening cycle expected).
Bank (SARB) concerned Bear Flattening: short-term bond yields Bull Steepening: short-term bond yields fall at a
about the potentially negative rise faster than long bond yields (often precedes faster rate than long bond yields (often precedes
implication of volatility drivers interest rate increases). interest rate decreases).
(namely, the weaker rand and
higher crude oil prices), the
Sources: Bloomberg, Futuregrowth
Bank deems it prudent to
“talk tough” and even consider
raising the repo rate in the
of the view that, if anything,
02/ DRIVERS OF flattening yield curve, our focus
near term.
the market has been
too aggressive in pricing
THE NEXT BIG has already shifted to the next
potential major yield curve
This scenario, called a bearish monetary policy tightening
YIELD CURVE change – a bullish yield curve
yield curve flattening, is (see Figure 17 on the following ADJUSTMENT flattening (refer back to the
already priced in by financial page). Given that the market has interest rate cycle graphic). In
markets. However, we are priced in the move to a bear this case, the yields of longer-
THE NEW WORLD ORDER 201920 YIELD CURVE ADJUSTMENT
FIGURE 17: RATE HIKES ALREADY PRICED IN... SA FORWARD RATE MARKET
(PROBABILITY OF A 50 BASIS POINT OVER TIME)
200%
180%
180% 166% will remain relatively benign
160% 148% over the next 12 months.
140% 132%
120% 104%
This, in combination with a
101%
100% 84% fairly hawkish central bank,
80% 78%
60% 56% 60% is supportive of an eventual
40% 30% 35% decrease of longer-dated
20% 8% nominal bond yields.
0%
-20%
-40% FOREIGN INVESTORS
-60% HAVE REDUCED THEIR
-80%
-100%
HOLDINGS OF RSA
-120% LOCAL CURRENCY
-140% GOVERNMENT BONDS
1 2 3 4 5 6 7 8 9 12 15 18 21
The significant net selling of
01 October 2018 31 July 2018 18 July 2018
SA bonds by foreign investors
Sources: Bloomberg, Futuregrowth could be attributed to various
factors. These include risk
dated nominal bonds decrease disinflationary forces. With US higher prices of local goods aversion in response to
in anticipation of lower inflation yields more contained, and in and services, weak local growth significant emerging market
and the end of the monetary light of the fact that this remains might offset most of the turmoil, the gradual draining
policy tightening cycle. As this the global benchmark, upward negative relative price changes. of excess global liquidity
unfolds, longer-dated bonds pressure on local yields from this and SA idiosyncratic factors.
will render a higher return than source would be significantly LIMITED RAND Noteworthy is the fact that this
short- and medium-dated reduced. DEPRECIATION selling had been concentrated
PASS-THROUGH in nominal bonds with a
bonds (remembering that bond
THE RAND HAS SUGGESTS A STRONG term to maturity of eight
yields fall when prices rise). The
DEPRECIATED SHARPLY DISINFLATIONARY years and longer. With this
potential drivers of such an BACKDROP
AND APPEARS TO BE large and important section
outcome are considered below.
OVERSOLD As clearly illustrated in of the broader investor base
US TREASURY The rand has weakened Figure 19, the inflation rate significantly reducing their
MARKET YIELDS HAVE significantly since the end of and exchange rate have holdings of longer-dated
APPROACHED OUR FAIR the first quarter of 2018. While decoupled. Of course, the bonds (refer to Figure 20),
VALUE ESTIMATE nobody can predict currency combination of subdued future potential selling
Sustained strong economic movements with any degree global inflation, weak local pressure is lessened and, if
growth and a significantly of certainty, we can safely state economic growth and strong market conditions indeed
reduced unemployment rate, that the rand seems oversold competition in the retail sector turn more favourable, these
combined with moderate relative to our estimate of its has an important role to play. investors may be lured back.
inflationary pressure, afforded purchasing power parity Unless economic growth picks It must be stressed that this is
the US Federal Reserve (Fed) (Figure 18). While some of the up significantly, and in a very a technical market driver. As a
an opportunity to finally start recent weakness admittedly short space of time, we believe prerequisite, the fundamental
the process of interest rate might still find its way into that the inflation outlook drivers need to fall in place.
normalisation and raise its
policy rate for the first time in
FIGURE 18: THE RAND COULD STRENGTHEN… USD/ZAR EXCHANGE RATE ESTIMATE BASED
the almost 10 years since the ON PURCHASE POWER PARITY
start of the global financial
crisis. In the process, the US 16
Treasury market has drifted to 14
more realistic levels, with the
RAND PER US DOLLAR
12
benchmark 10-year Treasury
yield now close to our estimate 10
of fair value of 3.2% - 3.5%. 8
Although it could very well
6
drift to a higher level, we feel
4
comfortable that the market
now did most of the work by 2
appropriately pricing in this 0
shift, especially since we are
Jan 71
Jan 73
Jan 75
Jan 77
Jan 79
Jan 81
Jan 83
Jan 85
Jan 87
Jan 89
Jan 91
Jan 93
Jan 95
Jan 97
Jan 99
Jan 01
Jan 03
Jan 05
Jan 07
Jan 09
Jan 11
Jan 13
Jan 15
Jan 17
Jan 19
not convinced that this cycle
is going to be as strong as in
95% Confidence Interval USD/ZAR PPP Model
the past, mostly due to strong
Sources: Bloomberg, Futuregrowth
OLD MUTUAL INVESTMENT GROUPYIELD CURVE ADJUSTMENT 21
THE RISK TO FISCAL
FIGURE 19: BENIGN INFLATION… PASS-THROUGH FROM RAND DEPRECIATION HAS BEEN LIMITED CONSOLIDATION
REMAINS, BUT THE
R18 16,0 CLOUD IS NOT AS DARK
R16
AS IT WAS LAST YEAR
14,0
R14
Of all the drivers mentioned,
12,0
this is the most significant
R12
hurdle for bullish yield curve
INFLATION YoY %
Dollar-rand FX pass- 10,0
USD/ZAR
R10 through has decoupled flattening. Our thoughts on
from inflation rate 8,0
R8 the link between sustained
R6
6,0 low economic growth and
4,0 the negative impact on the
R4
fiscal situation, mainly via the
2,0
R2 tax revenue channel, and the
R0 0,0 resultant threat to the country’s
sovereign risk profile, are well
Jan 01
Jan 02
Jan 03
Jan 04
Jan 05
Jan 06
Jan 07
Jan 08
Jan 09
Jan 10
Jan 11
Jan 12
Jan 13
Jan 14
Jan 15
Jan 16
Jan 17
Jan 18
telegraphed. The question
is: what may contribute to
US dollar/rand exchange rate (LHS) SA headline inflation rate (RHS)
a change to our thinking?
Clearly, a recovery in the
Sources: OMIG Economic Research Unit, Futuregrowth
growth outlook, tax efficiency
gains at the South African
FIGURE 20: THE DAMAGE IS ALREADY DONE… FOREIGN OWNERSHIP OF RSA GOVERNMENT Revenue Service and some
BONDS (NOMINAL AND INFLATION-LINKED BONDS) improvement in expenditure
management at all levels of
45%
government will improve the
43%
outlook for much-needed fiscal
41% consolidation. In our minds,
NON-RESIDENT HOLDINGS
39% this is a significant red light that
37% might continue to overshadow
35%
the more favourable factors
listed above. Even so, a rate of
33%
change in the right direction
31%
may very well suffice for a
29% more muted curve flattening,
27% considering how much
25% negative news has been priced
in at this point in the cycle.
May 11
Nov 11
May 12
Nov 12
May 13
Nov 13
May 14
Nov 14
May 15
Nov 15
May 16
Nov 16
May 17
Nov 17
May 18
03/ OUR
Sources: National Treasury, Futuregrowth
INVESTMENT
STRATEGY
Considering the factors
FIGURE 21: GOVERNMENT’S BOND DEBT LOAD HAS A STRONG BEARING ON THE YIELD
discussed above, we are
CURVE SLOPE
cautiously optimistic about the
60% 150 rising probability of a scenario
30-YEAR/10YEAR SPREAD (BASIS POINTS)
where long-dated bond yields
55%
100 decrease at a faster rate than
50% short- and medium-dated
50 bond yields in the medium
GROSS DEBT/GDP
45%
term. This may also be seen as
40% 0 a reflection of at least some
recovery, with the possibility
35%
-50 of lower inflation towards the
30% back end of 2019 and a slightly
-100 better economic growth
25%
outlook. For this reason, we
20% -150 have used bouts of market
weakness over the past few
Dec 88
Apr 90
Aug 91
Dec 92
Apr 94
Aug 95
Dec 96
Apr 98
Aug 99
Dec 00
Apr 02
Aug 03
Dec 04
Apr 06
Aug 07
Dec 08
Apr 10
Aug 11
Dec 12
Apr 14
Aug 15
Dec 16
Apr 18
months to reduce our initial
significant underweight
MTBPS Debt Profiles Gross debt/GDP (36-month lagged) SAGB30 - SAGB10 Spread (RHS)
position in long-dated bonds.
Sources: National Treasury, Bloomberg, Futuregrowth
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