Against a backdrop of lower returns for longer, asset managers have been forced to venture “off the beaten track” in search of alternative sources of returns, along with a greater focus on risk management, in constructing optimal, well-diversified portfolios.
We are living in challenging times and SA’s GDP is expected to be even lower than the recently lowered global GDP forecasts. This is a difficult scenario for portfolio managers as lowered GDP forecasts translate to lower company earnings. The result? Lower future returns from traditional asset classes.
We expect the downward shift in returns relative to risk to be more pronounced in higher-risk assets (growth assets such as equity and listed property). Saying that, there is still a case for holding a substantial chunk of your portfolio in higher-risk assets.
If you look at the JSE’s Top 40 companies on a bottom-up basis, and build up a forward P/E for these 40 stocks, you’ll see a number of the Top 40 stocks are trading at a discount to fair value. To be able to extract maximum benefit from these fundamentally-driven valuations, being an active stock picker is important, as there is value to be had – value that an active stock picker is mandated to identify and exploit when constructing a portfolio.
Aiming for the highest possible return per unit of risk
There is more to future returns than only the long-term average that can be achieved. Different assets achieve returns with varying levels of volatility and uncertainty and, on a practical level, the level of “choppiness” with which a portfolio achieves its returns matters to investors.
With such a wide range of possible year-on-year outcomes per asset class, as portfolio managers we make sure that we build enough stability into the portfolio, so that when we have a sub-optimal return in any asset class, there’s plenty of built-in inherent protection to rely on.
A toolkit for stability
There are numerous ways that one can bring more certainty to the return outcomes of your portfolio.
This is one of the components of investing that lies within the control of the investor. If you’re able to sit out a market slump, asset class performances should eventually return to their long-term, expected averages.
Various studies have proven that broad diversification gives investors a smoother return journey. As the portfolio manager of absolute return multi-asset funds at Sanlam Investments, I have one of the most diverse toolkits in the country to build portfolios. Outside of the traditional asset classes of equity, bonds, property and cash, we also have derivatives, portable alpha and various alternatives including real assets to choose from.
But back to planes, cranes and rock and roll. In some of our funds, alternative investments are generating real positive returns for investors. Cranes, for instance, are physical, tangible assets that are defensive in nature and less sensitive to the economic cycle. Investments into aeroplanes, which are then rented out to some well-known, credible airlines, are delivering yields of close to 8% on average. In this case, the risk sits with the airlines and the manufacturer. These assets are on the Sanlam Investments UK platform.
And what about rock and roll? Sanlam owns music rights in the offshore space, where we target a yield of 5.2% – a relatively predictable and long-term stable source of returns in the portfolio.
As fund managers we use unconventional assets to get access to uncorrelated sources of returns, so we can push out the efficient frontier, providing higher returns per unit of risk taken. Within any portfolio construction framework, protecting the downside is very, very important, and the compounded effect of doing so should never be underestimated.
The third tool in our toolkit is tactical asset allocation. Put simply, this means being nimble and opportunistic where necessary and where valuations permit. In South Africa, we’re fortunate in that our markets are fairly deep and liquid. Where we see opportunities, we are able to move with agility.
As a practical example of what nimbleness entails for us, we really sweat the assets within our short-term interest-bearing component of the fund ensuring the best possible yield without compromising on credit quality.
As we go into a low-return, more volatile environment, investors – more than ever – need more certainty of returns. A true broadly diversified portfolio – even pushing the boundaries with planes, cranes, and rock and roll – is the surest way to meet this need. BM
Natasha Narsingh is head of Absolute Return at Sanlam Investments.
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