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Investment Strategy
Friday, May 22, 2015 - 02:16
Equity always wins

Investor behaviour shows that cash is generally favourable over the short-term, as it appears to offer security. But seen through a long-term lens, in reality cash is categorically the worst performing asset class. This was one of the key findings in the 2015 edition of the Long-term Perspectives review from Old Mutual Investment Group’s MacroSolutions boutique, which also shows that global and local equities have been the best performing asset classes over a period stretching as far back as 1925.

The long-term proprietary data has also been used to structure a proxy fund for the average balanced fund for South African investors, the MacroSolutions Balanced Index.
Old Mutual Balanced Fund Manager, Graham Tucker, says that their long-term data helps them screen out the myopia-inducing day-to-day noise influencing the markets and to focus on the long term. “In today’s world, information is more readily accessible than any other point in history, with a constant flow of data and news reaching us via multiple media channels. We inevitably give this noise more attention than it probably deserves,” he explains. “We believe that our Long-Term Perspectives review helps us and our clients take a broader view when contemplating the investment environment.
“Our proprietary index represents a typical diversified balanced fund, which blends our long-term data and incorporates the full spread of local and global asset classes at the portfolio manager’s disposal,” says Tucker. “It plainly shows the critical role that growth assets play in achieving the real return objective of a balanced fund and that they have been, and always will be, a significant portion of the Index.”
The review shows that since 1925, the long-term return from SA cash has been 6.7% a year. The best annual return was in 1985 when investors received a remarkable 21.7%, which shows how high interest rates were back then, and the worst return was 0% in 1938. Once adjusted for inflation, the long-term real return is 0.8%, making cash the worst performing domestic asset class. These returns would be even worse when adjusted for fees and tax, meaning negative real returns.
In line with their long-term data, Tucker says that inflation is the biggest enemy facing SA savers, given that it erodes spending power. “We can look at inflation in two ways: we can either reflect on how cheap goods were in the past, or we can look forward to see how far your money will stretch into the future. Purchasing power is even worse if the inflation rate is higher, highlighting how important it is to ensure investment to achieve inflation-beating returns in the long run.”
Looking at local equities, the data in Long-term Perspectives shows that over the last 90 years, the SA equity market has delivered a real return of 8.3%, but has swung between cheap and expensive relative to trend.
The importance of growing your wealth in real returns cannot be underestimated. Take, for example, education where, if costs continue to rise at the same rate seen currently, it will cost R308 000 to put a 10-year-old child through university and for a new-born child it will cost R1.1 million. Rising medical costs will pose similar problems, making a good case for embracing an increasingly healthy lifestyle.
John Orford, a Senior Portfolio Manager at MacroSolutions, says that this movement from low to high and vice versa is known as reflexivity – well demonstrated in the early 2000s bull market that drove the market from low to high in just five years.
Orford explains that although equity markets rise in real terms over the long term, data shows that in nearly one out of every three years investors have lost money in real terms. “While painful for investors, these periods of significant negative returns present opportunities,” he says. “For example, 2008 was one of the worst years for our market, but gave rise to opportunities to buy local equity, with the last five years being largely very good to investors who were prepared to take on risk in the aftermath of the Global Financial Crisis. The period 1975 to 1976 is another example, with the following four years were being beneficial for investors who were brave enough to take the risk and buy low.”
Turning to local bonds, Orford says that yields rose sharply from their multi-decade low on the 10-year nominal bond to 8.8% in January 2014, in response to higher US bond yields as investors priced in an end to the Fed’s quantitative easing programme and a gradual US policy normalisation. “However, since then focus has shifted to potential deflation in Europe and Japan, where bond yields have fallen to historic lows, dragging global bonds down,” he says. “In this context and supported by moderating local inflation and weak growth SA nominal bond yields have fallen below 8%.
“Looking forward, lower nominal yields mean lower future nominal returns, and strong capital gains also seem unlikely. However, SA bonds offer a real yield of more than 2% and should continue to benefit from the “search for yield” in the current environment of very low global bond yields. Inflation-linked bonds will likely deliver a 1.8% real return over the next decade — almost exactly in line with the average real yield investors have received since the 1920s.”

Graph: Long term real returns (annualised) 1929 to December 2014. Source: MacroSolutions.

Copyright © Insurance Times and Investments® Vol:28.5 1st May, 2015
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