By Paul Hutchinson, Sales Manager
Paul Hutchinson demonstrates that valuation alone rarely causes bear markets and that although caution is warranted, opportunities remain.
While it may not feel like it, South African and global equity markets are at all-time highs, and the current ageing equity bull market that began in March 2009 is now the second longest since the 1920s.
Figure 1: Equity markets are at all-time highs
Source: Bloomberg as at 26.10.17.
At more than one standard deviation expensive, equity market valuations (as evidenced by 12 month forward Price: Earnings multiples for the MSCI All Countries World and the FTSE/JSE All Share Indices) are high but, we believe, not excessively so. Globally, strong earnings growth supported by loose monetary policy (for now) is driving these valuations, with 2017 earnings on pace for the best growth in seven years.
Nevertheless, should we be concerned about these challenging equity market valuations?
Research undertaken by Investec Asset Management confirms that valuation alone is rarely the cause of a bear market in equities. In fact, 1987 was the only bear market since 1928 that was primarily the result of overheated valuations.
So, what then causes bear markets (note the following are not mutually exclusive events and therefore the percentages do not sum to 100)?
- 25% of bear markets were primarily due to shocks, for example the oil shocks of the 1970s
- 50% of all bear markets were triggered by an economic recession
- A rising cost of capital has been a key contributory factor in two-thirds of bear markets
- A significant rise in the cost of capital has had a 93% chance of triggering a bear market.
Shocks, by definition, are difficult to predict, but our proprietary recession risk indicators show a lower than 10% probability of a recession over the next 6 and 12 months. As for rising interest rates (and therefore the cost of capital), while the United States Federal Reserve’s (Fed) Open Market Committee has raised their benchmark interest rate to a range of 1% to 1.25%, real US interest rates remain negative. This situation is unlikely to change in the short term, even as Federal Reserve Chair, Janet Yellen signals further rate hikes. We believe that US inflation is set to remain low (driven by technological changes, globalisation, demographics and the debt overhang) and that the rise in US interest rates should therefore be modest and slow. Furthermore, while the Fed has recently announced plans to shrink its balance sheet, quantitative easing (whereby central banks purchase financial assets to increase liquidity) remains in place in Europe and Japan.
Caution is warranted although opportunities remain
Bearing the above in mind, we do believe that some caution is warranted, especially as the current ageing bull market cycle grows ever longer. As a result, while we remain optimistic for the prospects for Growth assets, given ongoing fundamental improvement, the positioning of our flagship global multi-asset fund, the Investec Global Strategic Managed Fund is somewhat more cautious than it was a year ago, as the portfolio managers build in Defensive positions. A long position in US 30-year Treasuries is an example of a recently introduced defensive position. A yield of approximately 3.2% at the time of the trade was attractive relative to our neutral rate forecast of 2–2.5%. We consider that this position will be likely to provide a positive return in the event of an equity market decline. The managers have also progressively raised the liquidity of the assets in the Fund with no small cap exposure and selling out of high yield credit exposure.
We do still, however see opportunities for return such as our exposure to Japanese equities. We consider that Japanese companies are cheap relative to their global peers, that the end of a long deleveraging cycle is resulting in much better Japanese economic performance and that they have been under-owned by overseas investors. Our exposure has been specifically focused on companies with strong or improving corporate governance, which are either committed to improving total shareholder returns through higher dividends and buybacks or have a strong restructuring story.
The Investec Global Strategic Managed Fund
The Investec Global Strategic Managed Fund has displayed the following characteristics:
- Equity-like returns over a full market cycle i.e. attractive capital growth through time,
- With two-thirds of the volatility of equities i.e. lower than equity risk, and
- More consistent returns than global equities over a full market cycle.
The Fund has achieved this by exploiting one of the broadest global multi-asset opportunity sets of any of its peers, thereby maximising opportunities for return and effective diversification, as evidenced by the following chart.
Figure 2: The Investec Global Strategic Managed Fund, attractive capital growth at lower than equity risk
Source: Investec Asset Management and Morningstar. NAV based. Since inception period: 01.08.89 to 30.09.17. *MSCI World in USD pre 01.01.11.
Annualised performance (%)
|1 year||5 year p.a.||10 years p.a.|
|Investec Global Strategic Managed Fund A Acc||11.3||6.7||2.9|
Source: Morningstar to 30.09.17, NAV based, (inclusive of all annual management fees but excluding any initial charges), gross income reinvested, in US$. Highest and lowest returns achieved since inception: 44.3% and -39.4%. Annualised performance is the average return per year over the period. Benchmark: 60% MSCI AC World NR, 40% Citi WGBI.
The Investec Global Strategic Managed Fund may, therefore, be well suited to South African investors looking to diversify their investments globally and who do not want to make the complex asset allocation decision themselves. Similar to the local Investec Opportunity and Cautious Managed Funds, the Fund exploits the broadest opportunity set by investing in different asset classes and changing this allocation at different points in the market cycle depending on the balance of risk and reward, which helps to ensure more consistent returns over time.
Investors can invest into the Fund’s dollar, pound or euro share classes via Investec Investment Management Services’ (IMS) offshore GlobalSelect platform, or any of a number of other global linked product platforms. The Fund is also available as a South African rand feeder fund, the Investec Global Strategic Managed Feeder Fund, and is accessible directly, via IMS, or via all the other local linked investment service providers.
Collective investment schemes (CIS) are traded at ruling prices and can engage in borrowing, up to 10% of portfolio net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the Manager, Investec Fund Managers SA (RF) (Pty) Ltd which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. CISs are generally medium to long-term investments and the manager gives no guarantee with respect to the capital or the return of the Fund. Performance shown is that of the Fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax and past performance is not necessarily a guide to the future. The value of participatory interests (units) may go down as well as up. Performance figures above are based on lump sum investments, using NAV to NAV figures net of fees with gross income reinvested, in South African rands. The value of participatory interests (units) may go down as well as up. Different classes of units apply to the Fund and the information presented is for the most expensive class. Fund valuations and transaction cut-off time are 16h00 SA time each business day. This portfolio may be closed in order to be managed in accordance with the mandate. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. A higher Total Expense Ratio (TER) does not necessarily imply a poor return, nor does a low TER imply a good return. Where portfolios invest in the participatory interests of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Fund prices are published each business day in selected media. Additional information on the Fund may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. Investec Asset Management (Pty) Ltd (Investec) is a member of the Association for Savings and Investment SA (ASISA). The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. All information provided is product related, and is not intended to address the circumstances of any Financial Service Provider’s (FSP) clients. In terms of the Financial Advisory and Intermediary Services Act, FSPs should not provide advice to investors without appropriate risk analysis and after a thorough examination of a particular client’s financial situation. Investec Asset Management (Pty) Limited is an authorised financial services provider.