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It’s time to get real about real return expectations

Looking forward – what to expect from your portfolios and how to position them accordingly.

Our unsolicited advice to clients is to cut unproductive debt and to reduce investment return expectations.

By unproductive we mean credit card debt and debt used purely for consumption purposes. The motivation is clear – interest rates are rising and this debt will become increasingly expensive. In this uncertain environment it will be good to ‘batten down the debt hatches’ and wait for the storm to pass.

Reducing investment return expectations is more complex.

An apt warning which unfortunately has become somewhat clichéd is the required warning on Fund Manager Investment Fact Sheets “that past returns are no guide to future returns”.

This warning is now highly relevant when focusing on the structuring of investment portfolios. It should also bring into focus that, as research has shown, over 90% of investment returns result from asset allocation decisions, notably how much of one’s assets should be invested in shares, bonds, equities, cash, alternative investments and how these should be weighted between local and off-shore markets. Just to complete the returns equation – the balance of returns are accounted for by picking the right stocks/bonds.

This past decade, with particular reference to South African investors, has been a golden era with virtually every asset class providing real returns – meaning returns have comfortably exceeded inflation and thereby maintaining the real value of money. This expectation for double digit returns has become so prevalent that it has been taken as the norm. Over the past year or so momentum or trend investors have ridden the crest of the wave while those more value circumspect investors are having difficulty keeping up with the high performers. One should not be surprised at this fact as it often reflects the tops of markets where euphoria and over confidence is often the forewarning of more difficult times ahead.

So what has changed to call for this caution?

Firstly for the past ten to fifteen years interest rates globally and locally have been in cyclical decline, meaning that:

  • Investors in the bond markets enjoyed initially high interest rate returns plus the enormous kicker of capital appreciation because as interest rates declined so the value of these instruments increased, particularly for longer dated securities.
  • Investors in property have been recipients of strong capital growth and improving rental returns.
  • The equity investors have been the beneficiaries of growing dividends, capital growth and at the margin cash flows shifting from the bond and cash markets in search of improved yields, resulting in high demand for quality shares which pay attractive dividends.

This shift has been exacerbated by Central Banks in most developed economies flooding these markets with money to prevent these economies going into recession and trying to avoid the scourge of deflation. In some of these major economies it now costs the investor for the privilege of lending to governments. This is clearly an unsustainable situation.


The magnitude of these dislocations is best illustrated by one of the oldest bond markets in the developed world – notably the Dutch market which has never witnessed such low interests in its nearly 500 year history.

The nervousness in the market is clearly being expressed in the sharp increase in market volatility. This volatility has initially been centered on the likelihood of the United States Federal Reserve raising interest rates in December, which could be the start of the reversal of global interest rates. After such a long cyclical decline, this change in direction is unlikely to be smooth and gradual. The effect of rising interest rates means the bonds lose value, it also suggests ‘in time’ a shift away from equities into bonds and cash.

With the scene being set, how is this likely to play out?

Well at one level if the US raise interest rates this suggests that the economy is improving and therefore for equities it means a rise in earnings which should be good for equities. This is true up to a point, as one must then look at the valuation levels in these markets, which in the recent past have reflected a chase after dividend yields, in order to compensate for historically low returns available in the fixed interest markets.

To get a simple handle on equity market valuations one needs to look at the price to earnings ratio of the market. The price to earnings ratio or P/E ratio is calculated by dividing the price per share by the earnings per share. This ratio provides a better indication of the value of a share over the market price alone. For example, all things being equal, R50 share with a P/E of 25 is more expensive than a R50 share with a P/E of 10.

If one looks at the JSE All Share Index today the P/E is around 19 when its historical average (mean) is around 15. In the US market the S&P 500 P/E is elevated at around 20.6 when the average is again around 15. Euphemistically, investment managers refer to these P/E as elevated, which is nice speak for saying the markets are expensive or fully valued.

Looking at South African P/Es over the past six odd years, whilst the market has compounded at 16.9% per annum, only 30% of this expansion is shown by earnings growth with the balance coming from P/E expansion, or investors being prepared to pay more for the dividend flow provided by shares.

Now in an economy which is suffering from the effects of:

  • Rising interest rates
  • Poor local productivity
  • A rapidly expanding government sector
  • Uncertainty with respect to both power and water supply… the list can go on. Then this expansion of the market P/E will be difficult to sustain, and the likelihood is that valuations will revert back to the mean or worse.

While it is not our investment philosophy to forecast future returns it is instructive to look at past returns and provide an order of magnitude of future return expectations – these market returns are provided by Coronation Fund Managers.

Asset class

Last 10 years (ZAR)

10 year forecast (ZAR)

Local equity


7% – 10%

Global equity


8% – 11%

Local property


7% – 10%

Local bonds


8% – 9%

Global bonds


4% – 6%



6% – 7%



6% – 7%


So what does all this tell us about asset allocation?

  1. An investor is not being compensated for taking on too much risk
  2. The international equity markets appear to be better value than the local equity market
  3. Cash is a poor long term option
  4. Bonds (particularly international bonds) look like a graveyard
  5. Currency is almost impossible to advise on, except to say the rand is an inherently weak currency when measured against most developed currencies, although having depreciated some 25% against the USD in the past twelve months one could say that it has gone too far too quickly and may recover from these levels.

For investors structuring long term portfolios it is a vital time to sit down with an independent financial planner to pave the way forward.

Paul Jennings is a Private Wealth Manager at NFB Financial Services Group


You must be signed in to comment.


There is nothing new here to competent investors.

But your final paragraph is telling: “For investors structuring long term portfolios it is a vital time to sit down with an independent financial planner to pave the way forward.”

In other words, come and pay us fees to put your money into products which we hope will clear inflation, with the caveat “that past returns are no guide to future returns”.

I’ve got a better idea: put your money in index funds which have traditionally beaten most fund managers over the long term.

End of comments.





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