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By Philip Liebenberg, 12 February 2014
It is times like this that it worth remembering that investment has always been about taking risk in the face of uncertainty and thus diversification is the cornerstone of a sound investment strategy, says Philip Liebenberg, head of absolute return at Sanlam Investments.
Liebenberg says in terms of asset allocation, Sanlam Investments currently prefers:
“We’ve taken a neutral position on SA listed property and local inflation-linked bonds, and we are underweight in local cash, international cash, international bonds, and SA equities.”
Liebenberg says both in SA and globally there has been a bull run in equities for the last five years, and property has also done well. “However, the start of US Federal Reserve tapering triggered a net outflow of capital from emerging markets last year, especially in the so-called ‘Fragile Five’ countries – Turkey, Indonesia, India, Brazil and SA – facing structural economic challenges such as large fiscal and current account deficits. This has gathered pace into the New Year and spread to other emerging markets with structural challenges.”
Given the extended valuations of most asset classes, the focus has shifted from growth to stability and capital preservation.
He says the local equity market has become expensive relative to its own history, other emerging markets, as well as the world developed markets. “Our preference is currently for the developed world equity markets, specifically Europe and the UK.”
The SA market is now trading at a 16.5 price-to-earnings ratio (PE), compared to an average of 12 over the last 50 years. “Our valuation of the JSE shows that the market is overvalued – the highest it has been since 2007. Whereas resources are fairly valued, industrials in particular are definitely overvalued – they are currently at the highest PE in 50 years, and there is a real possibility of capital losses in this sector. The stock market has experienced a pull-back recently but it is still trading at relatively high PEs and thus now is not the time to be passive about investments, on both an asset allocation as well as a stock selection level.”
Global equities, on the other hand, are trading closer to their long-term PE. Whereas US equities are relatively expensive, on a price-to-book basis Europe and the UK are trading at a discount to global equities in general and these markets therefore remain attractive.
Liebenberg says local bonds are starting to show some value, especially in the wake of the recent rate hike. “Over the long term they should produce nominal returns of around 7.25%. The real return on offer is attractive relative to alternative asset classes in SA. Inflation-linked bonds offer real returns of about 2%, which is slightly above our long-run required return of 1.5%. However, we believe conventional bonds offer more value.” In contrast, global bonds remain expensive and, due to structural issues such as high government debt levels and austerity measures, long bond rates globally are likely to remain low.
Liebenberg says when valuing property stocks, Sanlam Investments uses a long-run distribution growth rate of about 2% below inflation in the light of property companies’ inflation-adjusted rental income, as well as their required refurbishments. “Property dividend yields remain below our long-run required yields. Property is currently trading at a yield premium of almost 2% to bonds, so we prefer nominal bonds over property at this stage. We do, however, like global listed property, where we are getting an average dividend yield of above 6%.”
Despite the rand-dollar exchange rate depreciating by close to 20% on mounting current account and fiscal deficit concerns during 2013 – the biggest annual decline since its almost 40% decimation in 2008 – Liebenberg recommends not investing large sums of money offshore. “Of course, no one can predict what will happen to our currency over the next year, but we do believe the rand is undervalued. While it is always a good idea to invest some funds offshore on a monthly rand-cost averaging basis, it is probably not wise to commit a large sum offshore at the moment.”