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Risk on … risk off

In the current environment, is an investor being rewarded for taking risk?

We find ourselves in very interesting times where volatility has disrupted global markets and it seems this will continue for the short to medium term, with events like an interest rate increase in the US, Brexit, President Trump and our own battle to avoid being downgraded, all plaguing market sentiment.

The question everyone is asking is where to invest.

One thing history continues to prove is that there will be a lot of bumps in the short term, but these tend to get smoothed out over time and thus vitally important that one always remains a long term investor. The old saying “It’s not about timing the market, but rather time in the market” remains true.

However, what I am addressing in this article is what can an investor look to in the current environment.


Let’s first look at the favourite asset class of choice – equities. Equities are a great investment choice in that they provide an inflation beating return and good capital growth over the long term.

The graph below shows the current Price-to-Earnings (PE) ratio of the JSE. This is a ratio which gives one an indication if the market is expensive or not. As you can see, the JSE has been in territory considered to be expensive for some time. This does not necessarily mean that there is going to be pull back in the short term, but with the companies on the JSE having negative real earnings growth on aggregate, we will most likely see a period of muted returns going forward.



When we compare the JSE to a number of developed world’s PEs we see a similar trend. When compared with their long term averages most markets with the exception of Hong Kong look to be relatively expensive. Once again concerns around global growth and earnings expansion may lead to a low returning environment across all these markets.



Given that equities seem to be fully priced, coupled with the fact that markets are exhibiting excess volatility, where does that leave an investor?

We have been beneficiaries of an equity bull market for an extended period of time now and so strong capital appreciation has been what investors have become accustom to. However, in the current low growth and low inflation environment yield becomes ever more important and something that will drive returns.

What do we mean by yield?

This would be the interest from money market instruments, the coupon from bonds, rental from property and dividends from equities.

The graph below shows the current yield of the various asset classes. (Right to left – Equities, property, bonds, inflation)




The interesting thing is that that currently the South African 10-year government bond is yielding 9%. This means you can hold this bond to maturity and get an inflation plus 3% return, given the current CPI level of 6%. In a potentially low returning environment this is a largely attractive option for investors looking for stability. Looking at listed property, we can see that the yield is relatively low in comparison and this is in part a product of the robust capital appreciation this asset class has had over the last 10 years.

Therefore, we are left with a situation where bonds appear attractive, however one must always remain cognisant of the risks involved in any asset class. The two most important such risks for investing in fixed income instruments are duration risk and default risk.

Duration risk is effectively the risk of your capital being affected by interest rate movements. A bond pays you a set interest rate from the issuance, split into bi-annual coupons. If interest rates increase it maybe more favourable to be in floating rate instruments or purchase newly issues bonds at higher yields, and as such investors may sell the bonds to move into these instruments. This typically leads to a decrease in the capital value as downward pressure is exerted by sellers which results in the bond selling for a lower price to increase the yield and become attractive again to investors.

The longer the time to maturity, the more risk you run of interest rate movements effecting your capital. This is mitigated if you hold the bond to maturity as you will get your capital back. Due to this type of risk you find that most fix income managers have a very low duration between 1-3 years which reduces this risk. This means they are currently more conservative and want to protect client’s capital.

The second risk is the chance of a default. This means the company; government or institution does not pay back your capital or a part thereof. The price of this risk is factored into the yield offered by the issuer and the spread (excess yield over US treasuries of the same duration) is effectively the price of increased risk of default.

What’s then interesting to look at is international markets where we can compare the 10-year sovereign bond yield against the current dividend yield.


We can see that bond yields have been compressed right down through a series of expansionary monetary policies and the elevated desire for stable assets. Due to this, there is increased capital risk currently associated with global bonds, as because of the inverse relationship between yields and bond prices, the scope for further yield compression is far less than that of a pickup in yields – and subsequent capital compression.

The converse to South Africa is therefore that equities are providing better yields than bonds internationally and in some cases even offer real (inflation beating) returns. The argument goes further that some of the mega cap companies around the world like Nestle, General Electric and P&G who have been around through recessions and depressions and even World Wars may be sounder than some governments, i.e. less risk of capital loss through liquidation or default. Internationally, it seems that bonds hold a lot of risk for little reward, and although equities are offering more reward it must be remembered that they are also not without risk. 

So what does that mean to you the investor?

With the ever changing markets it is vitally important that in your portfolio you have exposure to a degree of active management, not only between the various asset classes, but also at a security specific level (i.e. within asset classes). In the fixed income space you would want a manger who is able to go up and down the yield curve, i.e. allocate between short and long dated bonds based on where they see value. Furthermore, active managers are able to include corporate debt in a portfolio which may act to enhance the yield.

NFB Asset Management’s Model Portfolios provide a further layer of pro-active management, further improving the investment process and making it more efficient. The table below shows the Model Portfolios performance over a number of time periods, measured against the various asset classes. What we can see is that not one asset class remains at the top throughout all the periods and that over the long term (5 – 10 years), growth assets typically tend to outperform i.e. equity and listed property. In the current environment the ability to combine the most appropriate mix is important.


We are not advocating that one should be completely invested in one asset class and that bulk switches be made, but rather that in times of excess volatility and somewhat out of tune valuations, there is an increased benefit of active management. It is in times like this where the decisions of fund managers allow for a limitation of downside risk, i.e. protect capital against large scale adverse market moves. Finally, it is always important to talk to your trusted NFB wealth manager about your asset allocation and ensure you have the right mix of growth and yielding assets that match your risk profile and needs.

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Stephen Katzenellenbogen

NFB Private Wealth Management


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