Nov 11, 2016 | Stafford Thomas
Passively managed funds may not offer the best returns in a difficult equity market
As far as investment nuggets go, this one’s an oldie and has almost always been a goodie: you can’t go wrong with an index tracker fund. This has long been the cry from the passive fund management fraternity — and, granted, they’ve been right for years (and have had a field day at the expense of active value managers).
However, just under three years ago things started to change, and the tide began turning against passive managers riding an index driven by a handful of overpriced, heavyweight shares.
After a rapid rise from the bearmarket low in February 2009, the bull market had essentially run its course by mid2014. Amid much volatility, it has since got nowhere, as shown in the JSE top 40 index’s 5% fall since June 2014 and 10% fall over the past 12 months.
Things could have been a whole lot worse over the past 12 months, though.
Big advances by resource shares Anglo American, AngloGold, Gold Fields, Impala Platinum and Sibanye Gold, which all rebounded from heavily oversold levels, and strong showings from Bidvest, Shoprite and Tiger Brands saved the day for the top 40 index.
The strength of these shares has gone a long way to counter the big shareprice losses sustained by former high flyers such as Brait, Mr Price, MTN, Richemont and Woolworths.
It’s also been fortunate that Naspers, the biggest driver of the top 40 index in recent years, hung in to produce a minimal 7% price rise. Naspers has a disturbingly high weighting of about 19% in the top 40 index.
A stalling equity market should not come as a surprise, says Ricco Friedrich of Denker Capital. The bull market, he asserts, was built on a very suspect fundamental foundation.
“Since the start of the bull market the advance in share prices has been primarily driven by a rising p:e multiple,” says Friedrich.
“The p:e rise was in anticipation of a strong rise in corporate earnings [across the market], which has not come.”
Between February 2009 and mid2014 the total annual return delivered by SA equity was 19%, of which 13% came from the p:e rise and only 6% from earnings growth.
It was the lowest level of earnings growth in any bull market over the past four decades and did no more than match inflation.
“The p:e rise is over,” says Friedrich. “There is not much left to drive index growth except, perhaps, for dividends.”
It has made for an uncomfortable situation. The top 40 now finds itself trading at a heady 21.7 p:e, the highest in almost two
decades.
It is at a level that has only meaningfully been exceeded by a record 26 p:e in April 1969.
“If there is no recovery in earnings there is a risk the p:e will fall back to its longterm average,” warns Friedrich.
Sumesh Chetty, cofund manager with Clyde Rossouw of Investec’s Cautious Managed and Absolute Balanced funds, also paints a gloomy picture.
“Over the next 10 years we do not see the SA equity market, as a whole, delivering growth of more than 4%6%/year,” he says.
In real terms, excluding inflation, it is likely to represent pretty much a zero return.
“10year bond yields are indicating inflation will average 5.8%/year over the next 10 years,” says Chetty.
“If you look at inflation over the past 10 years, it has averaged 6.2%/year.”
For Chetty and Rossouw, the outlook for inflation makes bonds an alternative to equity. “A 10year bond yield close to 9% [8.7%] is very attractive to us,” says Chetty. “It represents a real yield of about 3%.”
For investors still bent on equity, Chetty’s advice is to stay clear of passively managed funds. “We are definitely in a stock picker’s market again,” he says.
Friedrich agrees : “There are some fantastic value opportunities for stockpickers. Value investing is coming through strongly again.”
An area attracting Friedrich is that of shares whose prices were hard after the UK’s decision in June to exit the EU.
“We are adding to our holdings in Old Mutual and Investec,” he says. “We also like Capco [Capital & Counties] and Reinet.”
Evan Walker of 36One Asset Management does not entirely share Friedrich’s enthusiasm. “It is possible to pick individual stocks offering good value, but to build an entire portfolio out of them is immensely difficult.”
Offering advice to investors, Walker says: “It is time to be extremely cautious. If you do not have at least a fiveyear investment horizon you should not be in equity.”
Arguably, a fiveyear minimum horizon should always apply to equity investment. But it is particularly relevant at a time when SA is racked with political instability and is staring down the barrel of a downgrade of its sovereign debt rating to junk status in December.
These risks are scaring off foreign investors who have remained consistent sellers, offloading a net R101bn of SA shares in the first 10 months of the year.