The asset allocation challenges expected in 2022

Five balanced fund managers share their views.

Some of the critical issues facing portfolio managers of local balanced funds going into 2022 include the direction of interest rates, inflation, South Africa’s power issues and what happens in China.

A slowdown in local economic and corporate earnings growth and a possible resurgence of Covid-19 are also factors they are watching closely.

Balanced fund managers expect to find it more challenging to find opportunities in the local market, as many JSE-listed counters have had a good run. They also remain concerned about South Africa’s fiscal position and will closely watch developments around government finances in 2022.

A significant event for next year is the ANC elective conference. Investors expect Cyril Ramaphosa to win another term as ANC president, but it would be disruptive if he fails to do so.

Read the views of the five balanced fund managers Citywire South Africa spoke to:

Roger Williams, CIO, Centaur Asset Management

Stock-picking could be even more critical in 2022, as global equities face headwinds. We have already seen evidence of these headwinds as several prominent high-growth US stocks have declined more than 50% from their highs.

Further headwinds included central banks signalling their intention to cut back on unprecedented accommodative monetary policy and that inflation might not be transitory.

Investors also face the prospect of governments looking to raise taxes to fund Covid-19 induced deficits. A further challenging factor is that pockets of the US market have highly elevated valuations compared with history. This is reflected by the S&P 500 index’s real earnings yield, which has been at the lowest level since the 1970s.

Centaur believes longer duration equities, like growth stocks, are most vulnerable to the current market dynamics. Therefore, a halt to flows into passive funds could impact broader indices, leading to lower future equity returns in certain sectors. Hence, the Centaur BCI Balanced fund’s equity allocation at 62% is skewed towards high-quality, low-duration assets, which we believe will perform.

Locally, it has become challenging to find opportunities, as many SA Inc counters have had a good run off a low base amid rock-bottom interest rates.

South Africa also faces structural issues and a lack of political will to attend to them. However, South African politics has improved compared to a few years ago.

We think the local market offers attractive real fixed-income yields. But the risks facing South Africa’s fiscal position are genuine and are driven by factors outside of South Africa’s control, namely commodity prices.

Abdul Davids, co-portfolio manager of the Kagiso Balanced fund

The critical driver of the asset allocation for the Kagiso Balanced fund in 2022 will be central bank activity and the impact that it will have on equities and other assets classes.

South Africa is in a tightening cycle, and the US is withdrawing its stimulus. It is fiscal and central bank behaviour that will dictate how markets will evolve, given that we have had such a long period of rising equity markets and that rising tide has lifted all other assets classes.

Kagiso is bearish on the South African economy and underweight cyclical stocks in South Africa, notably banks and consumer stocks. That means we will gravitate towards global equities and global companies listed in South Africa.

We have 27% of the fund’s assets in foreign equities, which compares with our strategic asset allocation framework that sets the benchmark at 25% for global equity.

On fixed income, despite the challenges South Africa faces, the current bond market, especially at the longer end (2044 and 2048 maturities), offers attractive yields. You can get 10% plus yields on those. So we have quite a big position there.

We expect bond yields to moderate as we see a bit of a rally at the long end of the curve. So that will allow us to take some profits and decrease our bond position.

On inflation, only time will tell. US Federal Reserve Chair Jerome Powell has already dropped the word ‘transitory’ from his vocabulary. Our view is that inflation will moderate and decline. We don’t expect inflation to stay at current levels.

On global equity, Kagiso is substantially underweight US equities, as we think the US equity market is overheated. We are finding more opportunities in places like Japan and Europe.

Our top focus area is around equity valuation, both locally and globally. Our total equity exposure in the balanced fund is about 73%. So it is on the high side, and that is because we are finding value both locally and globally. Mid-cap shares are also an opportunity.

Citywire +rated Jacobus Lacock, co-manager of the Fairtree Balanced Prescient fund

Next year will provide important clues as to where South Africa is in the economic cycle. The post-pandemic economic cycle is different from the cycle that followed the global financial crisis. This one is maturing much faster.

A combination of higher nominal growth and lagging central bank action has accelerated the present cycle. This has created the risk that central banks might suddenly shift to close the policy gap.

A strong growth recovery and rising inflation drove financial markets over the past 18 months. But we believe policymakers and their actions will drive markets in 2022.

While macro conditions remain supportive of risk assets, we will likely experience high levels of policy-induced volatility.

Investors have been surprised by the higher-than-expected level of global inflation over the last 12 months, but inflation will start to fall from elevated levels during the first half of 2022.

The question is whether it will fall back to pre-pandemic levels, between 1.5% and 2%, or settle at higher levels. Fairtree believes inflation will remain higher than market expectations, even if central banks hike policy rates. Therefore, we continue to favour assets that provide inflation protection.

Central banks have deliberately become reactive. For example, the US central bank was already well into a hiking cycle in the past when the US unemployment rate was around 4%.

The Group of Ten’s central banks will hike rates over the coming year, but the overall policy environment will remain accommodative. As a result, it will take several hikes, potentially beyond 2023, for the Fed to raise rates above the neutral policy rate. In addition, China will ease monetary policy and offset higher rates in developed markets.

Economic growth will fall from elevated levels towards long-term trend economic growth over the next 12 months. The US consumer is in a strong position with healthy balance sheets, excess savings and job opportunities.

Next year, China will focus on economic stability and target higher growth. However, health-related economic restrictions and supply chain constraints remain key risks to growth.

The inflation, policy and growth environment call for a healthy mix of pro-cyclical asset allocation to allow for decent inflation protection and defensive assets to handle policy tightening.

Karl Leinberger, CIO, Coronation Fund Managers

The Coronation Balanced Plus fund has a large weighting to equities, especially domestic assets. It has a much higher weighting in bonds than in the past 10 years, and that weighting is at the back end of the yield curve.

The fund has minimal exposure to global bonds and is underweight in global equities. There is a risk that global equities will have a poor year because there is so much irrational exuberance. There is a high risk that local equities will have a very poor 2022 as well.

On bonds, South African state debt is on a knife-edge, and there is a risk that the government will lose its fiscal sustainability. We need to see fiscal discipline from the finance minister. South Africa is flirting with a debt trap. We have got rising inflation and interest rates. There is a lot to worry about.

The Coronation Balanced fund has a 51% allocation to domestic equities. If equities fall off, we will buy more, and if equities get stronger, we will take a little off.

The fund has a 20% allocation to bonds. If we lose confidence in government fiscal discipline, we will reduce that weighting.

The fund has a 21% weighting to international equities. If global equities have another strong year, we will take profits. If domestic and global equities do well, we will consider investing the money in cash or bonds.

A significant event next year will be the ANC elective conference. The market expects Cyril Ramaphosa to win another term as ANC president. I think that is crucial. There is a low probability that ANC delegates would not re-elect him, but it would be a disruptive event if it does happen.

Eskom is another big issue that investors will be watching. Do we have meaningful load-shedding? Are they able to make any progress with improving maintenance and grid reliability?

The big issue is the performance of the South African economy, particularly as it has slowed in the last month or two. All that pent up demand is out of the economic system, and employment has meaningfully lagged the economic recovery.

Citywire + rated Thys Vorster, CIO, ID Capital

Four key possible headwinds could face the ID Capital BCI Balanced fund of funds in 2022:

  • Local economic and corporate earnings growth could slow down;
  • The US Federal Reserve could make a policy error, which could generally hurt central banks’ credibility;
  • A Covid-19 variant deadlier than the delta variant could emerge and result in lockdowns and economic disruption;
  • There could be heightened tension between China and the West. In addition, there could be increased regulation in China.

Equities have benefited from extraordinarily easy monetary policy, but such a level of monetary policy is unlikely to persist in 2022.

As companies’ profit growth decelerates, we expect returns and price-to-earnings ratios to move closer to their long-term averages. ‘Non-transitory’ inflation and a US Federal Reserve that tightens policy too quickly due to unforeseen wage increases could threaten equity markets in 2022.

Looking at property, US house prices were on a tear in 2021. However, most analysts expect US house prices to increase at a slower rate in 2022.

With the Federal Reserve tapering its purchases because of rising inflation, we expect US mortgage rates to rise, and central bank rates are likely to follow.

Furthermore, a resurgence of Covid-19 could result in more lockdowns that would quickly reverse the improving office and retail property markets worldwide.

As far as bonds are concerned, a slower pace of rising interest rates would be positive for local bonds due to the steep yield curve.

Increased Fed tapering can lead to a short-term risk-off movement in bonds. In addition, increased inflation due to renewed supply chain constraints could translate into the underperformance of fixed-rate bonds and outperformance of floating-rate bonds.

As short-term interest rates rise, there will also be an opportunity to increase cash holdings.

Justin Brown is at Citywire, which provides insights and information for professional investors globally.

This article was first published on Citywire South Africa here, and republished with permission.

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