For now, cash remains an investors best option
With a rand set to be under pressure, global diversification is recommended.
With low, even negative, real yields on property and bonds and with equities likely to be affected by near recession conditions, Marriott believes that cash is the best option for investors at this stage. With a rand set to be under pressure, global diversification is recommended.
Marriott's decision to raise cash exposure in portfolios paid off comfortably during 2008. The investment house started the year with the following asset allocation:
Marriott Total Overall Asset Allocation as at 1 January 2008
The overwhelming cash weighting was based on the fact that:
1. Cash yields were higher than all asset classes at the time,
2. Property, bond and equity yields were all below historic averages as well as below inflation, hence real yields were negative.
3. Earnings growth was expected to slow.
As a result, investors in Marriott's South African funds have enjoyed capital stability, or at worst relatively small capital declines. On the international front, capital losses were largely masked by a weak rand. The income streams from all funds remained reliable and in most cases reflected growth.
The year ahead
The year ahead is likely to be difficult for all economies, with the global recession sweeping from west to east. It seems that the US is well ahead of the rest in the economic cycle, having been in a recession since at least 2007. South Africa is probably only really entering the recessionary phase now.
We would suggest that this calls for caution on the part of investors and would thus encourage them to err on the conservative side when structuring investment portfolios. The Marriott total overall asset allocation at the start of this year was as follows:
Marriott Total Overall Asset Allocation as at 1 January 2009
As can be seen, Marriott's stance remains very overweight in cash for the following reasons:
1. Although on a year-on-year basis SA inflation is likely to decline from current levels due to declining fuel and food prices, it is by no means contained when considering the medium term horizon of five years. Core inflation remains stubbornly high and above the reserve bank target of 6%. Increases in wages, electricity and imports remain above 10%. This must be taken into account when valuing the income streams of equity, property and bonds in SA; all of which currently offer negative real yields.
2. Interest rates are likely to be cut further, but this may be a short-term policy decision designed to address recessionary fears. In better times, the reserve bank would normally wait for positive real interest rates of about 5% before cutting, which implies that inflation would need to have fallen to 7% before the rate cuts commenced.
3. Given the harsh economic climate, we are likely to see very subdued earnings growth from SA corporates and domestic property - in some cases declining earnings. The resulting negative real dividend yields are unattractive.
4. Cash at the short end of the yield curve (call to 3 months) still offers the highest income yields at the lowest relative risk.
Marriott is focusing on defensive stocks in the relatively recession-proof sectors such as food, pharmaceutical, telecommunications and non-luxury clothing. Leading retail banks would normally be considered defensive, however caution should prevail when considering their exposure to securitised debt. We have always avoided resource stocks due to the unreliable nature of their income streams. In addition, the global recession is likely to have a prolonged negative impact on the prices of commodities.
Marriott's exposure to SA property is as low as the fund mandates allow. We also retain hedges reducing exposure further. Yields around 8% are very low relative to our medium term inflation outlook. This, together with minimal growth in earnings, make the asset class seem expensive.
Marriott has no exposure to domestic bonds as yields below 8% again make for an expensive income stream. Infrastructure spend will require considerable capital which could necessitate bond issues raised at potentially more attractive yields.
Although interest rates may decline, cash, in our view still offers the highest yields and the lowest risk.
After an awful year in the markets, the mega cap stocks in US dollar, sterling and euro are offering excellent value, with dividend yields now around 6% to 7%. With some growth in dividends from some of the biggest companies in the world, and low inflation, they look attractive. We believe that the US, Britain and Europe will be the first economies to emerge from the global recession and consequently these companies offer the best value to be found.
For the past three years Marriott has been very concerned about international property. The yields had reached levels below 4% reflecting an expensive income stream. Today, international real estate is back at yields of 8% to 9% and we feel the time is drawing near to consider reinvestment back into this asset class.
For a South African, international diversification is always prudent. Marriott believes that the rand is under pressure for the following reasons:
1. The current account deficit near an all-time high relative to GDP. To date, it has been funded by net foreign capital inflows. These may dry up particularly if our resource stocks continue to fall out of favour as a result of declining commodity prices. Capital outflows will consume reserves and will ultimately impact negatively on the currency.
2. The current political climate in South Africa is not conducive to foreign capital inflows and could increase the yield premium required from investments to compensate for risk.
3. Reducing the deficit would be difficult when considering the import content of the infrastructure spend, the extent of dividends and interest flowing offshore and the low commodity prices reducing export income.
In terms of international currency exposure, we remain equally weighted across US dollar, sterling and euro.
* About Marriott
Marriott began as Russell & Marriott in Durban in 1862, making it one of the oldest financial services businesses in the country. The company currently has over R8-billion in assets under management, and offers a number of investment products including local and international collective investment schemes. Marriott was acquired by Old Mutual in 2005 and now forms part of the Old Mutual Investment Group SA as an independent boutique.
Article by: Bronwen Barclay, Marketing Manager* - www.moneyweb.co.za