SA assets well-priced for diversification

By David Knee, Chief Investment Officer at M&G Investments

In the current environment of elevated uncertainty around high global inflation and slowing growth, diversification is one of the critical ways to help limit portfolio downside, taking advantage of many different sources of earnings and income. In our view, our local equity and bond markets are well-priced for building highly diversified portfolios. Here we share some of our latest positioning.

Looking offshore, we prefer total offshore exposure in our “house view” portfolios of around 25% across equities, bonds, property and cash. This is broadly in line with our modelling that indicates 25% as an “optimal” strategic allocation, given prospective long-term returns and volatility of non-rand assets. We currently see better opportunities in local stocks and bonds, even accounting for the sharp global price declines witnessed in recent months.

In our view, rising US interest rates and the emerging US economic slowdown could present greater downside risks to US corporate earnings and upside risk to bond yields than currently expected by the market. Consequently, our preferred global asset class is cash, and has been since the second half of 2021.

Meanwhile, we are also maintaining a broad diversification across our SA equity holdings. One of our key overweight positions is British American Tobacco (BAT), a company that tends to perform relatively strongly when global equity markets underperform.

We have seen this stock as  very cheap “insurance” for unexpected risk events like the current war.

Equally, Sasol is a large and overweight holding. Not only has Sasol’s valuation been extremely cheap, but it has already been, and will continue to be, a beneficiary of high oil prices. The company is benefitting from exceptionally strong cash flow generation, enabling them to pay down their large debt balances. 

We also have exposure to a variety of Resources companies, including Northam Platinum, Glencore, Sappi and  Exxaro. Our listed commodity producers have been enjoying high earnings amid the sharp run-up in commodity prices. This has benefited investors who have been earning free cashflow yields of around 20% from many of the miners.

What happens to spot commodity prices from these elevated levels is anyone’s guess: the factors of global supply constraints, continuing Russian sanctions and a brewing European energy crisis all suggest higher prices for longer, but a global growth slowdown and cyclical effects point to a decline. Spot price uncertainty is reflected in company valuations, where forward P/E multiples are broadly cheap. Outside of precious metals, where we are underweight, our portfolios are neutrally positioned in the miners, but overweight energy and chemicals.  

Our house-view portfolios are also overweight SA banks, which is one of the sectors least affected by rising inflation and where earnings should benefit from rising interest rates. Standard Bank, Absa and Investec are among our preferred stocks.

Local banks have been very responsible in their lending activities in recent years and have exited the Coronavirus crisis with healthy balance sheets. Going forward, they are well positioned to outperform over the medium term, absent a dramatic economic downturn.

Last but not least, South African bonds are currently very attractive for diversification purposes, with the 10-year bond yield offering 10.5%.  In our view, there is much that is attractively priced in the SA market.