Emerging market financial assets, including South Africa, delivered strong returns in 2010 driven by the combination of better economic growth prospects than the developed world and a wave of cheap money created by central banks in a desperate bid to escape another recession.
Though the world now seems to have avoided a double dip recession and locally, we look set for a consumer boom (driven by the lowest interest rates in 30 years, real wage growth and a much reduced debt service burden) our concern is that asset class valuations have run ahead of themselves and there now appears little room for error. This suggests to us that we will witness increased volatility in financial markets as investors grapple with issues like: are assets cheap or expensive; will there be a government default in Europe; will developed world economies continue on the path to recovery and has a bubble developed in emerging market assets?
According to co-portfolio managers, Henry Munzara and Eben Mare, of the Absolute Return Franchise at STANLIB, a safe place to ‘hide’ is in funds such as theirs as they look to provide the investor with the combination of capital protection and inflation beating returns over time. This Absolute Return approach to investing means that their funds are managed with a conservative mind set and that they only believe in taking market risk when they believe that the reward compensates for it.
“Given stretched asset class valuations and the macro economic uncertainties out there, we would be surprised if investors are sleeping well at night” says Mare. In the Absolute Return funds that they manage (Managed Flexible & Inflation Plus 3%), Munzara and Mare have taken a conservative stance and have reduced their exposure to growth assets (equity & property) in favour of defensive assets (cash, bonds and inflation linkers).
In addition, the remaining equity positions have been hedged out in such a way as to retain upside but limit downside participation. Munzara adds “there is a lot of good news priced into current valuations and little margin of safety, so we would rather go with our first principle to preserve capital and then look to grow it when opportunities arise again”.
The charts below show the track record of the funds that they manage over different periods to the end of 2010. In most periods, barring 36 months when equities delivered poor returns, they have been able to achieve returns ahead of inflation for investors while also providing safety.
“While both funds look to deliver capital protection in the short term, the difference in the two funds is that the Managed Flexible fund looks to beat inflation by 5% over the medium term while Inflation Plus 3% as the name suggests, targets 3% ahead of inflation. This means that the Inflation Plus 3% is a more conservative fund though both a run on similar investment principles” says Munzara.
Managed Flexible Fund
Inflation Plus 3%
Quizzed on the difference in their type of funds (Absolute Return) with the typical Balanced fund,
Munzara and Mare say that there are marked differences:
- The Balanced fund space is for people who are less worried about capital preservation but are rather more focussed on returns; as a result their investment horizon is typically longer than that of Absolute Return funds.
- Absolute Return funds therefore typically look to deliver on their objective by avoiding capital losses and then compounding, while Balanced funds typically rely on equity market performance to reach their objective.
- Absolute Return funds are therefore ideal for low-medium risk investors, those approaching retirement or those who have a cautious view on the likely direction of financial markets.