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    Leonard Krüger

    Portfolio Manager

    February 2022

    VIDEO: Can SA assets deliver in 2022?

    Article Summary

    In our first webinar for the year, Equity and Multi-Asset Portfolio Manager Leonard Krüger and Pieter Hugo, Chief Client and Distribution Officer, explain why SA assets still have the potential to deliver strong returns in 2022 and beyond, despite tougher conditions and more expensive valuations than last year. They examine how our multi-asset funds are positioned to take advantage of a diverse range of good opportunities in the local market, and discuss why we're excited about potential returns from certain holdings.

    After the unusually high returns from SA equities (and even local bonds) that investors enjoyed in 2021, some may be expecting lower results in the next few years. After all, some headwinds to growth are presenting themselves in the form of rising inflation, higher global and local interest rates, the potential of new Covid strains, geopolitical tensions, and political concerns both locally and abroad, all arising from the interconnected world we live in. Also, importantly, starting valuations for both SA equities and bonds are now more expensive than they were at the beginning of last year.

    However, at M&G Investments we still see many good opportunities for excellent investment returns across most SA asset classes over the medium term. This view is based predominantly on the fact that, even though our asset valuations did rise last year, this was off a very cheap base and those gains lagged many other markets in terms of both their absolute level and re-rating. Negative investor sentiment has weighed heavily on our local assets for many years, and this presents opportunities for further strong potential returns going forward.

    So what do we believe are the returns on offer for investors, and will they reward investors adequately for the prevailing risks? Our valuations analysis shows that SA equities are priced to deliver an after-inflation return of nearly 9.0% p.a. over the next 3-5 years, well above their fair value of around 7.0% p.a. This compares to global equities’ prospective real return of less than 6.0% p.a., which is why on an overall level we prefer SA equities to global equities in our multi-asset funds like the M&G Balanced and Inflation Plus Funds. In our view, the market is overly pessimistic about SA companies’ expected performances - there are many excellent businesses in South Africa like banks, retailers and miners that have demonstrated solid long-term profitability, and we believe many have the potential to deliver strong results going forward, with earnings and dividends showing a robust return to growth over the medium term.

    Many mining companies continue to experience elevated revenue and earnings as the prices of commodities remain at high levels, helping them strengthen their balance sheets as well and enabling large dividend payments to shareholders. These high commodity prices are supportive not only for the companies mining them, but also for the wider South African economy via growth, higher tax revenues and added consumer spending.  

    We are particularly excited about the return potential from our overweight positions in banks: Standard Bank, Absa and Investec are among the top 10 equity holdings in the M&G Balanced and Inflation Plus Funds. Banks benefit from a rising interest rate cycle as long as its pace and extent remain relatively moderate – as we currently expect from the South African Reserve Bank (SARB). By contrast, we are underweight insurers, where Covid related claims and business disruption remain a risk.  

    We prefer SA equities to property counters in our portfolios due to the continued structural challenges the listed property sector faces, such as oversupply in the office space, rising interest rates and negative rental reversions.

    Meanwhile, we believe local nominal bonds present investors with an attractive opportunity to earn lucrative returns over time. Despite last year’s strong total return, the yield on the 20-year government bond remains well over 10%, near its highest level since 2001. In fact, our valuation of the government bond market as a whole shows a potential real return of around 5.0%, compared to a fair value of around 3.5%. We believe this reflects overly negative market sentiment regarding prospective inflation and other risks such as the government budget deficit. SA inflation expectations remain relatively subdued compared to many other countries, and within the SARB’s 3-6% inflation target band.

    Global sovereign bonds are still offering investors negative real yields as a result of the historically deep interest rate cuts made by global central banks during the pandemic. We have reduced our global bond position further in favour of SA nominal bonds in the M&G Balanced and Inflation Plus Funds. We also hold more SA government bonds and fewer corporate bonds than usual (with the former’s weighting at 75% of our bond holdings in Inflation Plus), given that there’s little need for us to take on the additional credit risk at the current elevated yields on offer. We prefer longer-dated bonds due to the extra yield they offer as a result of the steepness of the local yield curve. We believe investors are adequately compensated for the extra risk associated with the longer duration. 

    SA cash continues to be an unattractive investment option for now. This is because of the very low base off which our rates are rising – leaving potential cash returns much lower than those from SA equities and SA bonds. As local interest rates rise, cash should become more attractive again. However, based on the SARB’s projections, it will take time before it becomes a viable option for longer-term investors. Given the large shift of local investors into cash over the past 3-5 years, investors will need to reassess their cash holdings very carefully.

    In conclusion, despite the risks – both known and unknown – presenting themselves in 2022, we believe SA equity and bond valuations remain attractive, and have the potential to deliver strong returns over the medium term. South African investors have an opportunity to continue to reap the benefits of well-priced assets across a variety of asset classes. This makes multi-asset funds a particularly appealing option in the current environment, and we believe the M&G Balanced and Inflation Plus Funds are well positioned to take advantage of these conditions. Both funds are ranked in the top quartile of their respective ASISA categories for the past year to end January 2022, and the Balanced Fund is rated in the top 10% of its peer funds over 10 years.



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