Almost a year ago, National Treasury surprised the investment community by announcing several amendments to Regulation 28, the key change being to allow exposure to foreign assets up to a maximum of 45%. Final amendments, published in July 2022, also confirmed new limits for infrastructure, private equity and hedge funds, as well as a definition (and prohibition) of crypto assets.
The changes are particularly relevant for multi-asset portfolios, where an increase in the potential allocation to a wider array of domestic and global assets has significant consequences. There is a growing narrative that the additional flexibility will automatically boost returns while possibly dampening risk. However, given the expanded range of opportunities and the impact of foreign exchange movements, the variability of returns naturally widens.
These new investment options have also become available at a time when more traditional asset classes have experienced increased volatility as the end of cheap money created financial upheaval. As a result, last year was incredibly challenging, especially given that relationships and trends that investors have relied on either broke down or, worse, reversed.
This begs the question, do we see a return to the old trends, where our positive view on global equities largely benefited performance, or does a new investment environment continue to emerge?
Figure 1: Will global equities continue to deliver long-term growth?
Source: Ninety One, as at 31 December 2022.
Volatility takes its toll on investors and increases the possibility of poor investment decisions, particularly in the short term. But heightened volatility can create more opportunities to buy or rebalance assets at lower prices. This applies not only to traditional options but to the additional choices. Given the increased opportunity set, it is therefore critical to assess whether what has worked for portfolios remains optimal for asset allocation and selection. And, with greater flexibility, do investment teams have the breadth and depth to fully benefit from the full range of options now available, or are they even appropriate?
Let us deal specifically with three new areas of interest:
Infrastructure assets benefit from a combination of defensive fundamentals and structural growth drivers, with the ability to generate inflation-protected income. They also typically have a low correlation with other assets, low sensitivity to the economic cycle and sustainable cash flows. Investing in infrastructure has become more common globally. It also has relevance for South Africa, given the deterioration of government’s fiscal position and effectiveness, as well as the lack of funding within state-owned enterprises (think investment opportunities in private electricity generation).
But infrastructure investments carry two significant risks for investors. They are illiquid and may not be saleable at the time an investor had originally planned to exit. They are also typically highly leveraged, which results in a heavy interest burden. We argue such investments are, therefore, not appropriate within the daily-priced/traded funds that we manage.
From a portfolio construction perspective, global credit provides substantially more liquidity and diversification benefits than domestic credit. However, woeful yields have, to date, all but excluded global credit as an asset class for consideration. Now, as yields have moved up (and spreads widened), the asset class has started to garner more interest. Unfortunately, central banks have severely distorted certain markets, and it will take time for those distortions to work through the system. For example, the yields now available on lower quality credit are eye-catching, yet a large part of the repricing has been driven by the increase in government bond yields.
So, while valuations may appear compelling, volatility in the global credit market remains significantly elevated. Despite the improvements in yield, when assessed on a risk-adjusted basis, we are of the view that the prospective return does not yet compensate investors for the volatility of the asset class. We further argue that while the economic cycle remains uncertain, credit carries default and spread risk, which is not appropriate for our typical investor. Once interest rates peak and global credit finds a footing, equities should outperform, and we would therefore prefer to continue to hold equity over credit.
The amendments also allow Regulation 28-compliant portfolios to allocate assets to private markets such as private equity funds, up to a limit of 15%.
However, private equity investments involve a higher degree of risk and may result in partial or total loss of capital. By their nature, alternative investments are complex, speculative investment vehicles. To add, the lock-up period of private equity makes it illiquid, and the speculative nature of many such opportunities are not in line with our philosophy. In short, we do not believe it is suitable for the typical investor within our Ninety One Opportunity Fund.
Given the market disruption, what is our view on more traditional asset classes that have been overlooked for some time?
Global cash |
Global bonds |
Global property |
Is there a way to effectively allocate to ideas that remove South African-specific risks? We argue that EM opportunities outside South Africa are too highly correlated with domestic opportunities, given the nature and tradability of our market. While the bulk of our exposure must still remain within our borders, we are unlikely to utilise our offshore allocation for assets that do not bring diversification and risk-adjusted return benefits. To add, within the global equities we own, many derive a significant proportion of their revenue streams and growth opportunities from EM countries, which should be considered.
Will the US enter recession? What is the rand doing in the next 6 months? How much is a barrel of oil going to cost next year? Most people forecast too much because it is easy and the thought of being right is reassuring. That is risky, because forecasts start to become something you do to justify how you want the world to work, rather than analysing how it actually works.
Predicting what is going to happen, particularly in the short term, is hard and nearly impossible to repeat consistently. Most macro events that experts try to forecast are infinitely more complex than we assume, and with so many forecasts made, accountability is lost. It is also easy to reverse-engineer the answers once things have happened to give an inflated sense of accuracy.
If it is so hard to forecast accurately, how then do we construct portfolios? Asset allocation does not simply live on a neat spreadsheet, and we are cognisant of short-term influences. Robust models do form the fundamental basis of providing a firm foundation. Our asset allocation is built from the bottom up, based on the investments we own (or can own), on a 5-year forward-looking view. We buy companies where we have developed a deep understanding of their outlook through fundamental analysis. The select businesses we own tend to be less reliant on macro forecasts and the economic cycle, which provides a greater degree of certainty to the outcome.
Maintaining a disciplined approach to asset allocation through the cycle is crucial to generating long-term wealth. But the allocation is by no means static. We have the ability to tilt the portfolio towards defence, growth or cyclicality based on our views. New global equity holdings are an example of this, where we recently initiated small positions that we will potentially add to when appropriate.
Figure 2: After a tough year, the opportunity set has improved
January 2022 vs. January 2023 – expected 5-year returns
Source: Ninety One, for illustrative purposes only. This is not the return of the Fund. Five-year expected asset class returns are based on disclosed reasonable assumptions and are not a reliable indicator of future results.
While commentators flip-flop between whether this year’s headlines will be dominated by an economic recession or a market rally, we will continue to look through the noise. Real returns are available within the investment options we have at our disposal, and we will continue to allocate diligently on behalf of our clients. These options have not changed dramatically, despite regulation amendments and a shake-up of markets. Our preferred asset class remains global equities, which still provide the best opportunity for growth. Domestic bonds counterbalance this view and provide real return opportunities. We believe we are through most of the pain and will not shy away from allocating meaningfully to risk assets when appropriate, while recognising that timing the market can be a hazardous endeavour.
Figure 3: Asset allocation of the Ninety One Opportunity Fund
Source: Ninety One, as at 31 December 2023.
Critics may suggest that we are overlooking opportunities, some of which have resulted from changes to regulation. But greater flexibility increases complexity and will not necessarily result in better outcomes for investors. Skilful managers with global expertise should, however, benefit. We have an established track record of successfully managing assets within the Ninety One Opportunity Fund, creating long-term wealth for our investors. Over the last 20 years, the Fund has been the best performer in its sector.1 In this time, regulation and market opportunities have changed meaningfully. We have adapted, stayed disciplined and deepened our global investment team. Let time put the odds in your favour as compounding only works if you give an asset time to grow.
1 Past performance is not a reliable indicator of future results, losses may be made.
Source: Morningstar, dates to 31 December 2022. Performance figures for the A class are based on a lump sum investment, NAV based, inclusive of all annual management fees, gross income reinvested. Initial charges are not applicable to this fund. A-class inception date 02.04.00. An individual investor's performance may vary depending on actual investment dates. Highest and lowest annualised returns (rolling 12-month figures): Jul-05: 43.8% and Feb-09: -15.7%. Please also refer to the Ninety One Opportunity Fund page on our website.