Jason Swartz, Portfolio Manager at Old Mutual Investment Group
The European Central Bank (ECB) has signalled that its rate hike cycle is far from over, after a small rate hike last week.
The ECB statement, which indicated that “interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target”, follows rising optimism levels around easing eurozone inflation, driven by a sharp fall in European wholesale energy prices combined with an easing of supply chain bottlenecks.
With no end to the hiking cycle in sight, South Africa’s leading balanced and multi-asset fund managers are going ‘off script’ in search of market-beating returns for investors through 2023, as they find it increasingly difficult to call patterns based on historic market performances considering the almost unprecedented market conditions they face.
“Many commentators compare today’s low growth, high inflation and high oil price environment to the 1970s and then suggest that fund managers can use these similarities as a magical, historical roadmap to predict market inflection points,” says Jason Swartz, Portfolio Manager at Old Mutual Investment Group’s (OMIG) MacroSolutions capability. Unfortunately, there is no rule or historic pattern that accurately predicts market peaks and troughs.
He adds that the best that fund managers can do is continually assess their asset allocation themes and valuations in light of prevailing macroeconomic conditions and based on these assessments ensure that their portfolios contain the correct mix of bonds, cash, equities and listed properties in both domestic and offshore markets.
“We rely heavily on macroeconomic inputs to perform our asset allocation function,” says Swartz, before singling out global inflation and rapid liquidity tightening (rising interest rates) as major influencers of fund manager decision making. It turns out there was nowhere for investors to hide in 2022, with inflation and interest rate ‘shocks’ causing the bond and equity asset classes to fall simultaneously.
The 10% improvement in US share prices during October 2022 has tempted many portfolio managers to increase their exposures to offshore equities; but Swartz and his team believe such buying action will prove premature. He adds that in terms of offshore exposure, it makes more sense to increase exposure to global bonds in current market conditions. With US 10yr yields just below 4%, global bonds offer reasonably attractive entry point relative to both its own history, and global equities. Additionally, this asset class should benefit from tailwinds created from global inflation peaking and increased risks to a global recession in 2023.
“Whether a multi-asset fund outperforms or underperforms its competitors largely hinges on its currency exposure, and effectively the ratio of its global to local assets,” says Swartz. And that means a credible view and risk management strategy on the rand versus US dollar is non-negotiable when building multi-asset portfolios.
His team believes the rand is oversold at current levels of around R17, 20 to the dollar, and predicts that improvements in South Africa’s fiscal accounts and terms of trade could provide tailwinds for the currency over the coming months. “The rand has a disproportionate impact on multi-asset portfolios, and that’s something we are paying a lot of attention to,” says Swartz, adding that at stronger levels of the rand to the dollar they would be looking to move assets offshore, because on a long-term basis they remain concerned about the country’s performance on reform, particularly in energy, infrastructure, and regulation, as well as fading tailwinds from strong fiscal performance from high commodity prices
Low economic growth (forecast at less than 2% for 2023) and weak business confidence are also predicted to weigh on the rand’s long-term prospects.
Armed with this currency ‘view’, portfolio managers can focus on the best return opportunities from domestic asset classes going into 2023. According to Swartz, SA equity has been cheap for some time and offers compelling value against equities in both developed markets and other emerging markets.
“Locally listed stocks have a much better chance of delivering positive earnings growth in the coming year than global counterparts, and these have proven quite resilient in a tough economic environment,” says Swartz. “Decent earnings from many of these firms will support a compelling price-earnings valuation of eight or nine times forward on the JSE.”
The argument for SA bonds is even more compelling following a disappointing performance from the asset class through 2022.
“There has been a lot of sovereign risk priced into our bonds and we expect some of that risk to unwind in 2023 and the fact that we are close to the peak in interest rates and inflation should support a rerating in the domestic bond market,” says Swartz. He adds that the 11% yield on SA government bonds far exceeds the 6% on offer from cash or 7% on offer from money market instruments. If bond yields turn during the year, then it is quite likely that SA bonds could deliver 15-20% return for multi-asset portfolios in 2023.
“On a risk-adjusted basis we have tilted our balanced and multi-asset portfolios towards SA bonds. We have actively bought bonds into weakness and are quite optimistic with the resulting asset allocation,” concludes Swartz, before offering a final word on the coming year’s inflation theme.
“Historically, cyclical sectors tend to outperform during periods of falling global inflation and increasing equity exposures to such sectors, while managing exposure to a global slowdown, will be a defining ‘play’ for 2023.”