Investors had a taste this past quarter of what could happen when the United States central bank “tapers off” quantitative easing: the rally in global equities cooled, the demand for bonds fell, pushing up yields, and there was uncertainty on markets around the world.
Locally, investors in shares, bonds and listed property all experienced small losses after the markets were spooked by a suggestion from Ben Bernanke, chairman of the US Federal Reserve, that the bank may ease up on purchasing US bonds, as well as fears of slower economic growth in China.
To create money in the US banking system and keep interest rates low, the Federal Reserve has been buying bonds, which has increased the demand for bonds and lowered bond yields. This measure has stimulated the US economy.
Coronation, in its latest market commentaries, says the expectation that US interest rates will return to more normal levels resulted in government bond yields rising around the world and in investors moving capital out of emerging markets and back to traditional safe havens in developed markets.
Global equity markets as measured by the MSCI World Index rallied by six percent at the beginning of the second quarter, but the rally reversed in May, and the index ended the quarter down 0.07 percent in US dollars, according to ProfileData. The flight from emerging markets saw the MSCI Emerging Markets Index lose 9.14 percent in US dollars in the quarter to June 30.
Ryk de Klerk, executive director of PlexCrown Fund Ratings, says negative investor sentiment towards emerging markets also affected South Africa’s equity market, resulting in the FTSE/JSE All Share Index (Alsi) ending the quarter down by 7.1 percent in US dollars.
The depreciation of the rand, which boosted local shares that derive most of their earnings offshore, cushioned the blow for local investors: the Alsi ended the second quarter down by only minus 0.22 percent in rands.
Chris Freund, portfolio manager at Investec Asset Management, says the reaction to Bernanke’s tapering comments was overdone, because a reduction in monetary stimulus would signal a continued economic recovery in the US.
It was surprising that the markets sold off as viciously as they did before the recent recovery, he says.
At this stage, equities still seem to be the best asset class over the medium term, as the major alternatives – bonds and cash – offer, at best, average returns, Freund says.
Michael Hasenstab, co-director of Franklin Templeton’s international bond department, says although turns in the monetary policies of the major central banks will cause some “market dislocations”, the tapering off of “easy money” does not mean that the money supply will be tight. Instead, there will be a gradual rise in interest rates.
Franklin Templeton believes the revised policies will still provide a lot of liquidity to the rest of the world, he says.
Despite the recent blip in foreign returns, South African investors who put their money into global or worldwide equity, asset allocation or real estate funds up to 18 months ago have earned handsome returns in rands. The latest quarterly unit trust data show average returns of more than 30 percent, and in some cases more than 40 percent, in these unit trust sub-categories.
The MSCI World Index returned 37.22 percent in rands over the year to the end of June. The depreciation of the rand by 15.46 percent to the US dollar assisted these returns, but even in US dollars, the MSCI returned a healthy 11.24 percent.
The recent volatility in global equity markets has not deterred many fund managers who are hedging their bets on this asset class to provide the best returns.
Coronation says that, as long as accommodating monetary policies continue, equities remain its preferred asset class, and the company favours global equities over domestic ones.
Global equities still have attractive valuations (measured in terms of price-to-earnings ratios, or PEs), and some of the world’s best companies are trading on compelling PEs while growing their earnings and dividends steadily, it says.
Coronation’s domestic balanced (or multi-asset) funds remain at the maximum permitted offshore limit of 25 percent, the company says.
Charles de Kock, manager of Coronation’s Balanced Defensive Fund, says a return to more normal interest rate policies will lead to rising bond yields in developed countries. These yields will spread to developing countries, where interest rates on bonds will also rise to compete for the pool of global savings.
Currencies that benefited when investors came to their markets in search of higher yields will come under pressure once the flow of investments into their markets stops or reverses, De Kock says. In anticipation of these changes, the rand has weakened materially and local bond yields have moved higher and are likely to go higher still, he says.
Although it is clear that returns from bonds will be poor, it is uncertain what this will mean for equities, De Kock says.
Coronation believes the Federal Reserve will be very careful about reducing its stimulus of the US economy and will do so only if the economy is healthy enough, he says.
As the global economy continues to recover, Coronation thinks it will be unwise to reduce exposure to equities too early, De Kock says.
Investec’s flagship multi-asset fund, the Opportunity Fund, remains exposed to offshore markets at close to the maximum of 25 percent of the fund.
Sumesh Chetty, a portfolio manager in the Opportunity Fund team, says although most economic indicators are pointing to further strength in the US economy, Investec is slightly less optimistic about global prospects than most investors because it is of the view that increases in bond yields will result in further pressure on consumers in the form of higher mortgage bond repayments.
Nevertheless, the strengthening recovery should give investors more appetite for US equities and bring a stronger US dollar with it, he says.
The Opportunity Fund’s management team has struggled to find attractively priced opportunities locally but has been able to find them offshore, where risk is lower, cash flows are superior and valuations are better, Chetty says.
Paul Hansen, director of retail investment marketing at Stanlib, says Stanlib was expecting global equity returns of 15 percent in rands for this calendar year, but global equities had already returned 32.6 percent in rands by the middle of this month.
Global equities have had a strong run since July last year and are up more than 50 percent since then in rands, despite a period of consolidation over the past few months, Hansen says.
Stanlib is of the view that global equities will continue their upward trend, but much of the return may already have been earned, he says.
Stanlib remains overweight in offshore equities, preferring them to local equities, he says.
Global property has come back strongly and has reached an attractive level after a sharp correction, Hansen says.
PSG Asset Management is also keeping its investments in offshore markets at the maximum levels, despite the fact that these markets have already had a strong run.
Shaun le Roux, portfolio manager at PSG, says that PSG is a bottom-up manager – it chooses shares based on its research into whether they represent good businesses in which to invest and not on trends in the economy.
PSG is still finding good opportunities to invest in excellent companies offshore that will produce better returns than quality companies listed on the JSE, he says.
PSG’s offshore allocations are mainly to stocks in the US, but the manager is also invested in some attractively priced European companies, Le Roux says.
MARKETS AT A GLANCE
Three months to June 30
FTSE/JSE All Share Index (Alsi): –0.22 percent with dividends reinvested
SA Bond Index: –2.27 percent
FTSE/JSE Listed Property Index: –0.35 percent
MSCI World Index: 7.29 percent in rands and –0.07 percent in United States dollars. The rand fell 6.4 percent against the US dollar and 8.1 percent against the euro.
Twelve months to June 30
Alsi: 21.01 percent with dividends reinvested
SA Bond Index: 6.26 percent
FTSE/JSE Listed Property Index: 24.02 percent
MSCI World Index: 37.22 percent in rands and 16.01 percent in US dollars. The rand fell 15.46 percent against the US dollar and 19.25 percent against the euro.
Past three years to June 30
Alsi: 18.11 percent a year with dividends reinvested
SA Bond Index: 10.66 percent a year
FTSE/JSE Listed Property Index: 23.58 percent
MSCI World Index: 21.25 percent a year in rands and 11.24 percent in US dollars. The rand fell 22.78 percent (8.26 percent a year) against the US dollar and 27.79 percent (10.28 percent a year) against the euro.