Balanced funds delivered strong returns for investors in 2020. Through markets that plunged, and then rose, in rapid succession, managers of balanced funds were able to apply tactical asset allocation to extract the best performance from equities, bonds and the performance of the rand.
What stood out in global equity markets, including South Africa, throughout 2020 was how they rallied ahead of an economic recovery, which, we believe can be explained by two factors.
The first is the inverse exponential function of bond yields: as bond yields dropped, the discount rate applied to global equity markets rose, which improved share price valuations. This change stimulated demand for growth shares, and for companies that could deliver relatively resilient earnings, such as Naspers.
The second factor, which is South African-specific, is that the composition of the JSE has diverged from the economy. Currently, Naspers and Prosus, which are effectively international shares, account for 30% of the JSE`s value, while precious metals and gold shares account for almost 20%. That means that as fund managers, we take a view on the global economy, rather than only the South African economy.
Outperforming assets in 2020
Assets which provided exceptional buying opportunities and enabled our funds to deliver double-digit returns in a low-inflation environment, were the rand, listed property and commodities shares.
2020 was one of the most volatile years ever for the rand/dollar exchange rate. In April, the rand came close to R18/$, which allowed us to profit from foreign assets, either through selling and repatriating dollars to rand, or shorting the dollar outright. As global liquidity eased and emerging markets returned to favour, the rand strengthened.
Listed property struggled in the first half of 2020, but performed better in the second half. Our funds, which have not held listed property for some time, took the opportunity to add it to the portfolios again.
After an initial sell-off, commodities ended the year far stronger than they started. Our funds were able to take advantage of the dips to adjust our equity positions and we even held some commodity ETFs in the first half of the year.
Ongoing themes in 2021
Our current asset allocation is weighted towards domestic and global equities, and domestic bonds, with very little cash.
Towards the end of 2020 and into early 2021, risk assets have performed strongly, buoyed by optimism about the rollout of vaccines. We expect emerging markets and commodities will continue to do well in the first quarter of this year.
Dollar weakness has persisted, as US fiscal policy has changed fundamentally. Under the new US administration, different tax and spending policies will be pursued, which will be particularly positive for emerging markets. President Joe Biden`s US$1.9 trillion American Rescue Plan may drive inflation higher and benefit equities.
The earnings of South African companies proved to be relatively resilient throughout the pandemic, underpinned by non-domestic-focused shares. While the second wave of the pandemic, new variants of the virus and resulting lockdowns are a concern at present, we expect those events will ease as the year progresses and the impact on company earnings will be muted.
On local equities, we favour quality businesses and those that will continue to grow and provide value to shareholders. Our biggest single exposure, by some margin, is the communications sector, represented by our holding in Naspers. We favour PGMs, particularly Impala Platinum, Northam Platinum and Anglo American Platinum, and hold BHP as a diversified miner. We also have exposure to financial shares, namely FirstRand and Sanlam, which have good recovery potential.
Low bond yields in developed markets will support South African bonds this year and we have maintained a relatively high level of bonds in our portfolios. After the 300 bps interest rate cut, bonds are offering a healthy margin over cash, with the yield on SA`s long bond currently above 10%.
We expect domestic inflation will remain low this year and into 2022, and fiscal risks are adequately priced into bond markets. With central banks globally expected to keep support measures in place for some time, real yields on South African bonds are attractive, and we have seen an increase in foreign investor interest. We expect South African bonds will deliver double-digit returns over the next 12 months, and see the fair value for our 10-year bond at close to 8.5%.
Potential risks
The biggest risk, as we begin 2021, is the pandemic`s effect on South African business and consumer confidence in SA. If there is progress in rolling out vaccines by the second quarter, confidence will improve, which should stimulate investment and spending and benefit asset prices.
Other risks are, firstly, that if SA`s fiscal and economic situation worsens more than anticipated, it will be negative for fixed income investments, and secondly that commodity prices may be currently elevated, reflecting expectations of China`s continued economic recovery.
https://moneymarketing.co.za/the-resilience-of-balanced-funds-in-turbulent-times/
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