Morningstar expects SA shares to excel

Fund manager opts for higher exposure to local companies with good  prospects.
The outlook for local companies stands out amid the continuing trend among SA investors to move their money, and often their families, abroad. Image: AdobeStock

Morningstar Investment Management SA is convinced that South African companies will continue to perform well in 2022, so much so that the firm has weighted its portfolios towards local companies.

MD Victoria Reuvers says 2021 was by no means a dull year and, while it looked like markets performed well, there were some “land mines” that couldn’t have been avoided.

She mentions the bottom in global bond markets, the debacle surrounding China’s Evergrande real estate group, the unexpected slump in Chinese technology stocks, and the effect of it all on emerging markets.

“If we look at the various asset classes across the calendar year, the first point that stands out is the broad positive returns across all nine the asset classes in 2021,” says Reuvers.

“The second is the rotation in the ranking, highlighting the importance of diversification.”

However, it is her views on the outlook for local companies that stands out amid the continuing trend among SA investors to move their money – and often their families – abroad.

Read: Top-performing unit trusts in SA over the past decade

Local equities

“After a seven-year drought … the past 18 months have seen a strong rebound in SA equities with broad-based returns across sectors. While 2020 saw resource shares [mainly platinum and diversified miners] performing well, 2021 saw a rotation into more unloved areas of the market.

“Looking back at 2021, the strongest performing areas were what we would term SA Inc shares, namely banks, retailers and select industrial shares.”

Read: Do local shares still offer value?

What caught many investors by surprise in 2021 was the sharp fall in the Naspers and Prosus share price, which accounts for almost 20% of the All-Share Index.

“A combination of concerns regarding the Chinese government’s interference in their market with regards to the new regulation for select technology companies, alongside the disappointment surrounding the Naspers/Prosus share swap and the company restructuring, have proved to be strong headwinds for these shares,” says Reuvers.

She notes that fixed income wasn’t so ‘fixed’ either.

Fixed income managers didn’t have an easy year, with what had appeared to be a stable asset class experiencing a lot of volatility.

SA government bonds remain perplexing …

“We are seeing good value in this asset class, with bonds offering a yield of around 9.5%,” says Reuvers. “This is almost 5% ahead of cash and 4% ahead of inflation, which is unheard of in global markets.”

Read: Developers soar on China’s easing proposals: Evergrande update

“Despite this attractive yield, foreigners have not been investing in our bond market to the levels they have previously. As a result, this asset class is generating a decent yield for investors, but has been subject to market volatility this year due to the lack of foreign support.”

It wasn’t only SA fixed income managers that had a tough time, she adds.

“Global fixed income managers had it even worse. Global bonds were one of the worst performers in 2021. With starting yields at low levels and bond yields rising throughout the year, this led to bondholders experiencing meaningful capital losses.”

Holding cash in portfolios seems unwise, with Morningstar pointing out that not only is the nominal yield low at around 4%, it is in fact offering a negative real yield with that inflation above 5%.

Warning signs

Reuvers says it seems nothing could stop the global market bull, but she strikes a cautious tone when talking about US tech shares. “While value shares and unloved sectors such as energy and UK equities certainly rallied and were solid contributors to portfolio performance, the tech stocks in the US reached stratospheric levels – both in terms of performance and in price.

“In our opinion, this sector is starting to carry a striking resemblance to the tech bubble of the late 1990s.”

She elaborates: “Firstly, the market is trading at extreme valuations and is experiencing new initial public offerings in the magnitude last seen in the late 1990s.

“If it walks like a duck and talks like a duck … ”

Thus, Morningstar Investment Management decided to remain “materially underweight” in the large US technology companies.

She quotes Warren Buffett of Berkshire Hathaway fame to drive home her point: “Be fearful when others are greedy and greedy when others are fearful.”

There is much exuberance, easy money and excitement in certain areas of the market, and the level of optimism and crowding makes “us fearful”.

Victoria Reuvers. Image: Supplied

“There will be good news stories for companies and sectors … with investors prepared to pay extreme prices just to own these golden companies,” she says. And again paraphrases Buffet: “But remember that the price is what you pay, but value is what you get.”

“Now is the time to be vigilant and to ensure that you are getting value for what you buy.”

Morningstar Investment Management is however seeing pockets of opportunity in emerging markets.

Portfolios

The investment management firm has opted for meaningful exposure to SA domestic companies, but its fund managers hint that they were unsure of Naspers and Prosus for a while.

“We’ve always had an implied 10% cap exposure to Naspers and Prosus combined, which also helped limit drawdowns when these shares fell,” says Reuvers, admitting that in the years this share drove returns the cap resulted in a contained drag on performance.

“Nevertheless, risk mitigation is key. We are prepared to forego some upside in order to protect the downside.”

Morningstar Investment Management indicated that it has remained fully invested offshore, with the majority of this allocation held in global equities. This allocation has been a solid contributor to performance, despite the rand fluctuating wildly between R14.50 and R16.50 per dollar.

Reuvers admits that Morningstar Investment Management’s “healthy” exposure to emerging markets detracted marginally from performance lately, but its fund managers remain optimistic looking forward.

“Our meaningful exposure to SA government bonds has not provided the returns we had envisaged, but when compared to cash, it has been the right decision.

“We remain confident in this holding as we expect interest rates to rise in 2022 – albeit in small increments – and this should be beneficial for long-dated government bonds,” she says.

“The fact that we have very low cash yields and very low global bond yields has pushed investors towards riskier assets such as stocks, which seemingly continue to go up … and up, and up. Let’s not forget that equity markets looked fairly expensive going into 2021, and many key markets are again looking expensive going into 2022.”

Morningstar is seeing attractive opportunities in select areas of the market. Its keeps a “healthy” exposure to select equities with exposure to SA government bonds in favour of cash and global bonds.

“Our portfolios are constructed to invest in areas where we see good long-term upside, but also to ensure that risk is considered and there is a balanced exposure to both growth and income assets.

“You may hear some commentators saying that markets are expensive and now is not the time to be invested, whereas others say that things will just keep going up.

“To this we would say there is never a right time to invest – the key is just to be invested and to remain invested,” she says, referring to the importance of actively managing portfolios according to changing trends in international financial markets.

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