Balanced fund investing: Finding return opportunities in a new normal world
2020 proved to be a rewarding year for investors in well-diversified South African balanced solutions. Large volatile price movements, driven by the pandemic, across several asset classes, presented return opportunities for active balanced managers. Skilfully taking both tactical asset allocation and stock selection opportunities at an asset class level meant the Balanced team at STANLIB was able to deliver clients healthy inflation-beating returns. This proved the resilience of a balanced fund and the importance of asset allocation through unusual market conditions.
Looking forward, the flexibility of a balanced fund means managers can take advantage of the opportunities presented by the constantly changing macro-economic environment while remaining committed to their investment philosophy.
What could these opportunities look like as we head through 2021?
The new normal in a post-Covid-19 world could mean no more “free lunches”. For the past decades South African monetary authorities have held the view that maintaining meaningful positive short-term real rates will protect SA from foreign capital outflows and act as an incentive to encourage local savings. However, as we know, the onset of Covid-19 has prompted unprecedented monetary intervention as countries have endeavoured to protect both the health of society and the wealth of their economy.
Led by wealthier developed markets, Emerging Markets have followed suit by reducing local interest rates dramatically. The SA Repo rate was reduced by 300 bps during 2020, taking money market rates down to the same level as current inflation. This means investors investing in cash will now struggle to achieve attractive inflation-beating returns.
The sustainability of prevailing low short-term interest rates that provide stimulus and support during these times becomes a key factor to inform asset allocation decisions. Globally negative real rates are well entrenched, as monetary policy has remained accommodative and business friendly. Countries such as the US have clearly indicated that the current close to 0% short term rate environment is likely to persist for several years, and normalisation of interest rates in the rest of the emerging market world is expected to be a gradual process, at best.
Investors who have become accustomed to earning a real return from a relatively low-risk investment would need an appropriate balance of their portfolio in riskier assets to maintain this real return outcome, provided their overall investment objectives are aligned. The SA bond market’s current high level of real rates is a case in point.
The current SA 10 year Bond yield of 8.9% is attractive relative to the ALSI dividend yield of 2.7% and SA’s inflation outlook of around 4%. The expectation of lower interest rates with moderate inflation should also be good for corporate investment activity in SA. Coupled with a re-stocking cycle and robust commodity prices , this will renew GDP growth. The steep yield curve presents a potentially rewarding investable opportunity to investors, especially those willing to take a slightly longer-term view.
The current level of bond yields has been priced by the market for all the known fiscal challenges in SA. In the event of a marginally improved outcome, a flattening of the yield curve could be expected, resulting in a large capital appreciation, particularly from longer-dated bonds. This repricing could be as a result of lower government expenditure and better-performing tax receipts, less longer-dated issuance with the introduction of 3-10-year floating rate government bonds or a deduction in weekly issuance based on overfunding achieved in the current fiscal year.
Re-thinking level of risk to achieve returns
The risk profile of real rate investment opportunities has changed and, in all likelihood, will persist for a number of years. This means investors need to re-think the level of risk they are willing to take to achieve real returns. Investing in a well-diversified balanced investment has proved to deliver real returns through different cycles, as managers have the flexibility and skill to take advantage of opportunities presented by the market as a result of asset price changes.