Key take-outs from balanced funds in 2021 and future expectations

RAYHAAN JOOSUB Co-founder and Deputy CEO, Sentio Capital Management

Returns on South African balanced funds have been disappointing over the past three years. Rolling five-year real returns (before fees) have averaged about 2% over the past three years (see Figure 1); well below the historical average of 6.5% real achieved over the past 18 years. What have been the major lessons learnt over the past five years?

Foreigners don’t need to invest in SA

Global investors are spoilt for choice in terms of return opportunities and don’t need to invest in SA. The past five years have seen a dramatic collapse in our political process, exacerbated by the Covid-19 pandemic, which has led to a collapse in the country’s growth potential and seriously compromised the country as an investment destination for foreigners. Hence, we have seen a substantial derating of SA-focussed companies and bonds, which has negatively impacted returns for balanced funds.

Don’t underestimate the impact of central bank liquidity on markets

Global markets are more than ever dependent on liquidity from central banks. This dependence might be unsustainable in the long term; however, when economies and markets experience a crisis, don’t underestimate the impact that easy central bank policy may have on markets – this can often result in long periods

when markets dislocate from underlying economic performance. Bet against central banks at your peril. Global equity, in particular tech and quality, the key beneficiaries of easy money, has been a great place to earn excellent returns for balanced funds.

You can still make money on SA equity despite the poor economy

Despite the weak local economy, mining companies (supported by higher commodity prices and supply discipline), as well as tech and quality (supported by central bank liquidity), have all experienced excellent returns, despite the market itself being weak. Searching for pockets of excellence can still contribute positively to a balanced fund.

What can we expect over the next five years?

Looking forward, we expect balanced funds to deliver a real return of 6% over the next five years. The biggest contributors will be SA equity on improving revenue growth and margins, and a rerating as the SA economy recovers from the damage wreaked by the Covid pandemic. SA bonds, currently yielding above 5%, more than compensate for the country’s increased fiscal deficits and funding risks. We see scope for SA bond yields to decline over the next five years, supporting good real returns.

We are expecting more muted returns from global bonds due to rising developed bond yields as central banks normalise policy. Global equity returns will be lower than the past five years as tech stocks derate from current elevated levels and operating margins recede on higher inflation.

To conclude, SA balanced funds should have a tailwind from improving domestic asset markets; however, as always, nimble asset allocators should tactically be able to add another 2% by skilfully allocating where the best risk-adjusted return opportunities exist.