Views Article – Sharenet Wealth

Think twice before selling out

Previous editions of The Insider have addressed the need to treat equities as a long-term commitment. An equity investment thesis should be at least 5 years; shorter than that lies the realm of speculation. We revisit this idea this month to see whether the long-term view still holds true, especially in light of all the anecdotes surrounding capital flight into income products.

Drawing on the past 60 years of ALSI financial data, it is apparent that Yes, there are cycles and Yes, equities rebound after downturns. In the past 60 years, there have only been 3 periods where the 5-year annualised return was below zero, although we did come close in 2013. If anything, this highlights how bad recessions actually were back in the 1970s!

JSE ALSI PR, shown annualised 5-year rolling returns, 01 Jan 1965 – 30 Sept 2019
Source: Morningstar

The current period shows a similar dip towards zero. We aren’t there yet and it’s not certain that we will get there. The obvious deduction is that the time to sell out of equities was April 2014, at the recentpeak, before the slide began. Of course, things could get worse but selling now seems a particularly bad idea. Not only does it crystallise losses, but it also prevents participation in any market recovery. Where do these unhappy investors go? It’s an expensive time to go shopping for yield-generating fixed income.

The shift out of equities is real, however.  Looking at Morningstar figures, there has been ZAR 8bn+ in outflows from SA general equity unit trusts in the 12 months through to 30 Sept 2019.  That’s a massive change in investment patterns.  Presumably those investors haven’t seen or don’t believe the chart above. Perhaps they are spooked by cash outperforming equities over the past 5 years.

In parallel, Corion Capital recently published a short video that demonstrated where funds have been flowing in the SA market. It’s worth having a look if you haven’t seen it yet.

Some drivers behind this move may include:

Real” diversification – overwhelmingly, academic and empirical studies show that asset allocation contributes the lion’s share of portfolio returns. Shifts from equities into balanced and income solutions might be just a re-allocation exercise.

“Fear” diversification – it’s a thing that some South Africans are fearful of the local South African landscape and feel the need to squirrel away funds offshore just in case.  While this may be sensationalist, it is a real phenomenon and one that should be taken seriously, especially as there is a solid justification for building a portfolio with differentiated and uncorrelated revenue streams.

Calling the cycle – at 10 years, we are now officially in the world’s longest bull run. It may not feel all that bullish but technically it’s true: the markets have been on a rising trend (albeit slowing) since March 2009.  We have written before about the prevalent sense of market fatigue. Some investors could be translating this into action by voting with their feet.

Demographics – lifestyleallocation is also certainly a contributor.  As people age, advisors move them out of riskier assets and into more stable, income-generating products.  The youngest Baby Boomers are now approaching 60; perhaps we are witnessing a demographic portfolio shift.  Are these outflows just the start of a new wave that will see billions more moving away from equities? It’s too soon to tell and we don’t have the necessary information. It seems like a rather excellent topic for someone’s dissertation at Stellenbosch.

Whatever the cause, investors are moving their funds into ‘safer’ assets. It is the responsibility of financial advisors to point out requirements for long-term growth. Likewise, it is in the best interest of fund managers to offer products that accommodate investors’ fickle natures. Having a full-on equity product isn’t for everyone. It makes sense, especially now, to offer an equity solution that de-risks investors.

Equity markets may go down. Recessions or sideways markets are likely part of the “new normal”.  But when an investor has a 20-year time horizon (or more), equity is needed to generate returns. It is the asset class best suited to beat inflation, produce dividends, re-invest for future growth and attract favourable taxation.  In our mind, the issue these days therefore seems to really be about risk.

If managers are able to offer products that provide equity exposure without full equity risk, it can only benefit investors. Alternatives to a single “reduced risk” preserver-type product could include Absolute funds, passive ETF portfolios or traditional hedging through asset allocation. These should be considered and taken up by investors: otherwise, these same investors will likely be complaining about poor relative performance in future.

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Andrew Cormack

Head of Distribution at Methodical Investment Management

Andrew has 18+ years of experience in financial markets, primarily as a credit analyst and debt syndicate specialist within European HY/leveraged credit markets. Before joining Methodical Investment Management, he was a Senior Director at Fitch Ratings in London, where he had responsibility for structured finance CDOs across the EMEA region.  He holds a BA in Economics & East Asian Studies (McGill University, Canada), a MSc from the London School of Economics and is a CFA Charterholder.