· SA Equities 8.7% (13% end October)
· SA Bonds 14%
· SA listed property 25.68%
· Rand/Dollar 5.4% stronger
· Foreign Equities 0.92% in US$
· Emerging market equities 8.7% in US$
· SA Cash 5.28% (3.17% after 40% tax)
· Inflation 2.84%
At the beginning of 2010 I expected equities to outperform Cash and inflation and hoped that the JSE All Share would reach 31 815 points (15% for the year). These expectations were based on the state of the world economy at that time and the fundamental valuations for the different asset classes.
I knew that interest rates had to come down and that holding money in cash could not be seen as an investment. I believed that the South African Rand should be above R8 to the Dollar and that where you had very little or no international equity exposure you should make use of the strong Rand to invest in those markets. Here I have been a tad premature and the Rand surprised.
I advised clients to remain true to strategic asset allocation principals when investing money and to follow the following specific guidelines:
· For money required in the next 3 years: Invest in cash
· For money required in 4 years from now: Invest in Preference Shares
· For money required 5 to 9 years from now: Invest in Balanced Funds
· For money required only in 10 years and later: Invest in Equity Funds
This strategy would have ensured sufficient cash for short term expenses and would have ensured participation in any growth in equities. The following example demonstrates the outcome:
For a 60 year old client investing R2.5mil, needing R10 000pm after tax to spend, the following investments with allocations and returns materialised year to date 31 October 2010:
· SA Cash 15% allocation 5.76%
· SA Preference Shares 5% allocation 12.96%
· Balanced Funds 28% allocation 11.90%
· SA Equity Funds 31% allocation 16.05%
· International Equity 21% allocation 1.51%
This portfolio provided a 10.15% average return for the year till 31 October 2010 (7.22% real).
At the beginning of 2010 there was still a lot of uncertainty as to the sustainability of the world recovery. The SA equity market has performed well during 2009 and the big question was whether the companies would be able to support the inflated share prices by generating higher earnings. This proved to be the case. The JSE lived up to my prediction of being very volatile and bounced between 26 500 and 28 500 points until October.
Then the US decided to approve the second Quantitive Easing Package (QE2) worth US$600bil, and people started investing in shares and bonds again. Year to date we have seen R60bil flowing to SA bonds and 20bil to SA shares.
The problem for 2011 and beyond
In short we can say that the developed world (USA and Europe), still experience a lot of problems. The US is printing $ to get the economy going which in turn weakens the $ and makes the US exports cheap but also strengthen the currencies of developing countries like SA, making our Rand too strong and thus our exports very expensive.
The low interest rates in the US (0.25%) combined with the massive amount of money the government is printing motivates investors to look for places to invest. In SA they can get 6-7% on bonds and up to 5% dividends in some blue chip shares. The result is international investors buying SA shares at rather expensive valuations.
The problem is that one day, in a couple of years from now, the abundance of money is going to give rise to inflation which will in turn see US interest rates rise. That will spark a sudden and severe turnaround of capital flows, seeing international investors selling their expensive SA shares and bonds and relocating the money to the US.
The Rand will fall out of the sky like a rock and probably overshoot any rational level against the $, spiking SA inflation with the resulting rising of interest rates and eventually company earnings coming under pressure and any overvalued shares taking a nosedive.
When all of this might play out I don’t know. The only thing we can do now is to make rational decisions based on fundamental valuations using information of the day. I would therefore recommend the following investment approach based on asset allocation:
·Cash: only hold cash where you will need to spend it over the next 3 years.
·Preference Shares: Margins on these shares have fallen away and should be replaced by balanced funds.
·Balanced funds: The managers of these funds should be in a good position to manage funds for the medium term return.
·SA equity funds: It will be risky to invest in a SA share index like the JSE All Share. The selection of individual shares will be crucial to ensure that only cheap (value for money) shares are held in the portfolio.
·International equity: There are many international companies that are still very good value for money. One should utilise the strong Rand to invest in these companies. This will also protect against a weakening of the Rand.
Selecting specific shares
As I have predicted in 2009, shares were priced very attractively after the 2008 selloff and a general re-rating was a big probability. Investing in an index fund with the low cost advantage would have been a good choice. Going into 2011 things are very different. Most fund managers agree that shares in general might disappoint and the selection of specific companies will be very important.
The following two areas are highlighted as good potential:
Established international companies with a big part of their earnings being generated in the BRIC countries and
Companies with an established infrastructure in Africa.
Conclusion
It seems as if most investment professionals agree that although shares are not cheap, sitting in cash will produce no return, and that whilst the US keeps on printing money, and developed countries keep interest rates low, the place to be will still be shares, specifically those companies with close ties to the BRIC countries and Africa, as well as undervalued Blue Chip US shares.
We know that this is a party that will continue for a while longer and that the hangover is going to be severe one day, but over the longer term those investors attending the party with a good supply of headache tablets will have the benefit of good memories one day, although having to have stayed in bed for a day or two at one point.
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