Income is a dominant driver of most asset class returns over the long run. John Stopford and Jason Borbora, co-portfolio managers of the Ninety One Global Multi-Asset Income Fund
, recently wrote a thought piece1
in which they said; “given the importance of income, the decline in yields on most asset classes since the Global Financial Crisis (GFC), and the further fall during the COVID-19 crisis, appears to bode ill for conservative investors ... The good news, however, is that there are still attractive opportunities across a range of asset markets and securities.” They conclude, that the key to thriving in this income desert is to build a diversified portfolio by selecting attractively priced individual bonds and equities offering decent yields, but whose income payments are comfortably covered by sustainable cash flows.
Income also dominates as a driver of total returns when deconstructing the make-up of South African equity, property and bond index returns. In fact, over the past 10 years, capital has detracted from the total return generated by South African property and bond indices, while reinvested dividends are typically responsible for approximately one third of cumulative total returns for SA equities, as evidenced in Figure 1 below. Importantly, this is at an index level and does not represent the opportunities available at an individual security level to bottom-up stockpickers. While we do not have index data going back 10 years for South African investment grade corporate credit, we would expect the picture to be similar to that of government bonds, being that the income received exceeded the total return due to a portion of capital being lost to corporate defaults.
Figure 1: Income is a material source of returns over the long run
Source: Ninety One benchmark database, 1 August 2010 to 31 July 2020
Current income environment
Official interest rates have been cut to very low or negative levels in most developed countries and the South African Reserve Bank (SARB) has rapidly followed suit. Year-to-date, the SARB’s Monetary Policy Committee has cut the repo rate by a substantial 3%, from 6.5% at the start of the year to the current rate of 3.5%. This collapse in the repo rate will have a material impact on the returns investors can earn from money market and cash-like investments; we can expect the average money market unit trust fund to trend down towards the current repo rate of 3.5%2
. And while South African government bond yields have spiked, this is not entirely a good thing as it reflects an increase in the perceived risk of lending to the South African (SA) government.
At the same time, in the wake of COVID-19 and the related recession, many companies have suspended the payment of dividends. Globally dividends were down 22% in quarter 2, 2020, the biggest 3-month fall since 20093
. Share buyback programmes have also been widely halted. In South Africa, the South African Reserve Bank went so far as to advise SA banks to preserve capital by not paying dividends, and real estate companies are deferring dividends as they attempt to shore up their balance sheets. Glencore, Capitec, Investec, Redefine, Rand Merchant Bank and Sasol are all examples of companies that have suspended the payment of dividends this year. Unfortunately, quantifying the resultant economic damage will take considerable time and therefore it is too early to know when many of these companies will be able to reinstate their dividends.
Simply put, the income desert has come to South Africa.
Preventing desertification requires an innovative approach
As a drastic response to the growing desertification of western and north-central Africa, countries across the region implemented the extraordinary idea of transforming their degraded landscapes through a “Great Green Wall” stretching across the width of Africa, from Senegal in the West to Djibouti in the East. The aim of this Great Green Wall of trees 10 miles wide and 4 350 miles long is to create a barrier against climate change and for it to form a transitional zone between the arid Sahara Desert to the north and the belt of humid savannas to the south.
Investment managers, on behalf of financial advisors and investors, will need to look to a similarly innovative response to ensure real returns for conservative investors. Fortunately, there are attractive opportunities across a range of asset classes and underlying securities, which continue to be identified and exploited by the Ninety One Quality capability’s structured, disciplined and effective investment approach.
In constructing portfolios, the Quality team seeks to balance risk and returns, and considers more than just income (and any potential for income growth) when evaluating individual securities within the various local and offshore asset classes available to them – equities, bonds, credit, property and cash. Where appropriate they also consider the potential for any capital appreciation and the impact of any currency movement in calculating the individual security’s expected total return, increasingly important in this lower yield world. Understanding how the various securities and asset classes behave in a holistic portfolio is also a key consideration, as is considering any downside sensitivities. By way of example, the US dollar acts as a through-the-cycle shock absorber for SA portfolios and there is a negative correlation between SA bonds and high-quality global equities.
The Ninety One Cautious Managed Fund
The Ninety One Cautious Managed Fund
(the Fund) is the ideal vehicle for investors who require a low risk, conservative investment option that still has the potential to beat inflation substantially and take advantage of rising markets. The Fund has a strong focus on capital preservation and absolute returns driven primarily by income through active asset allocation and stock selection decisions; the Fund’s impressive track record is evident in figure 2 below, which illustrates that the Fund has only had 1 negative 18-month return out of 151 rolling 18-month periods.
Figure 2: Ninety One Cautious Managed Fund upside participation while limiting drawdowns
Past performance is not a reliable indicator of future results, losses may be made. Source: Morningstar, dates to 30 June 2020, performance figures above are based on lump sum investment, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested, fees are not applicable to market indices, where funds have an international allocation this is subject to dividend withholding tax, in South African Rand. * Inception date 31 March 2006. Annualised performance is the average return per year over the period. Individual investor's performance may vary depending on actual investment dates. Highest and Lowest returns are those achieved during any rolling 12 months over the period specified. Since inception: Feb-10: 23.8% and Feb-09: -6.8%. The Fund is actively managed. Any index is shown for illustrative purposes only.
Rather than trying to outperform other conservative funds or the market, the portfolio manager aims to achieve inflation-beating returns at the lowest possible risk – the fund targets inflation plus 4% over rolling 3 years. When making investment decisions the possibility of losing money is a more important consideration than the potential investment gain. This risk-cognisant approach is not only reflected in our approach to asset allocation, but also in terms of our equity stock selection.
In a recent reportback, co-portfolio manager and head of SA Quality, Duane Cable, emphasised that we continue to focus on the highest quality opportunities. In the context of South African assets this means select government bonds, given the high coupon (real yield of approximately 6%) and resultant attractive risk / return characteristics, especially compared to SA equities and cash (and even considering downside risks to the fiscus). We then balance this with growth assets in the form of high-quality global equities with low leverage and low economic sensitivity. We favour those businesses that generate high and sustainable returns on invested capital in excess of their cost of capital. Importantly, these quality stocks tend to outperform in difficult market circumstances because of their balance sheet strength and more resilient earnings. Validating the strength of this approach, Microsoft, which is the second largest offshore holding in the Ninety One Cautious Managed Fund
, has joined the list of top 10 global dividend payers for the first time.
In summary, we do not believe it appropriate to position the Ninety One Cautious Managed Fund
for any event or crisis. Instead, we maintain a balance of exposures which offers protection against a range of potential outcomes, while generating inflation-beating returns over the medium to long term. As always, we remain unwavering in our commitment to growing capital in a prudent manner.
Watch the FastView video:
1 Thriving in an income desert, July 2020.
2 See Cash trending towards trash, May 2020.
3 Janus Henderson.