When listening to local fund managers at the moment, it does appear that almost everybody has the same idea when it comes to asset allocation.
This is reflected in the fact that South African balanced funds tend to have a very similar look about them. The asset allocations and top ten holdings of the three largest South Africa multi-asset high equity funds, as shown below, bear this out:
Source: Fund fact sheets (click to enlarge)
Apart from Allan Gray’s lower allocation to local bonds, and Ninety One’s underweight position in local equities, these portfolios look a lot more similar than one might ordinarily expect, including their relatively large cash holdings and commodity exposure.
“I think the local asset management industry is very extremely positioned,” said Duncan Artus, co-portfolio manager of the Allan Gray Balanced fund.
“I don’t remember everyone being positioned so similarly except for 2001 and maybe 2008.”
This takes the form of large exposures to locally-listed rand hedge stocks, being at or near the 30% limit allowed to offshore equities – generally in growth stocks – and an overweight position in South African government bonds.
“All those things make sense to me,” said Artus. “But the contrarian in me gets excited when we see everyone positioned the same way.”
Which is not to say that Allan Gray differentiates itself particularly with regards to its exposure to local assets. In fact, having traditionally been ‘a low duration house’, the firm is has bought a significant share of government bonds.
This may reflect that fact that there is something quite different about the current crisis. As manager of the Ninety One Opportunity fund, Citywire + rated Clyde Rossouw, noted, this is not like the market crashes of the late 1990s, early 2000s or 2008.
“I think what makes this one different from a South African perspective is that this is a South African crisis,” said Rossouw. “In the great financial crisis, the fortunes of many businesses in South Africa were very little changed. The banks sailed through it.
“In this one, we have made decisions that have exacerbated the impact. And South Africa prior to the crisis was already starting down the barrel of a recession.”
This explains why Allan Gray, South Africa’s most famously contrarian asset manager, is not rushing into local equities, even though Artus noted that “we think there are a lot of depressed South African shares.”
“If you told me there was no virus and you told me where relative share prices were, I would be selling AB InBev and British American Tobacco and buying banks and local cyclicals,” said Artus. “But I haven’t done it.”
However, he does feel that Allan Gray is not “quite as bearish on some local stocks” as many other managers, simply because there is potentially a lot of up-side in any “normalisation”.
“I don’t think Microsoft could double, for example. But I’m pretty sure Nedbank can,” he said.
Where Allan Gray’s portfolio does diverge more significantly is offshore, through its partner Orbis. There the fund does have higher exposure to more value-type stocks. The Ninety One Opportunity fund, however, concentrates its offshore holdings in quality names like Visa, Microsoft and Moody’s.
“These are businesses that are world class and have structural growth opportunities over many, many years,” said Rossouw.
“That’s important when a South African investor thinks about the role that equities should play, which is multi-year growth. It’s not obvious to us that many South African businesses can provide us with that.”
“Stocks in South Africa have looked cheap, but we are very wary about domestic stocks,” he said. “We think that this lockdown is going to take a very severe economic toll and that will be felt across sectors. Think of every company today that is cutting costs – which is a euphemism for cutting its headcount. Those people are consumers in South Africa, so there are going to be lots of second round effects.”
The challenge, however, is that over the past few years local investors could at least find safe, real returns in cash if they opted not to be exposed to local equities. Now, they no longer have that luxury.
“With interest rates around 3.5%and maybe going even lower, the protection that you think you are getting in cash is not going to be there any more,” said Chester. “You are going to have to look at riskier asset classes.”
Don’t expect mean reversion
“If the world has taken the view of printing money, cash is going to be one of the worst asset classes to be exposed to,” he added. “You do need to look for real assets.”
This is particularly true given the risk that inflation could return globally.
Equities will therefore remain a key allocation in any portfolio. However, investors have to be selective in the local market.
For Chester, that means buying businesses that are either positioned in a growing niche, or are ‘exceptionally well managed’ with strong balance sheets.
“It is going to be a tough economic environment,” he said. “There are a lot of companies that are going to struggle. The concept of mean reversion is not necessarily gong to play out the way it did after the great financial crisis.”
Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.