Daily Equity Report
Seed Weekly - Asset Class Valuations ? The Year to Date
An important part of Seed’s multi management process is performing monthly asset class valuations using our in-house quantitative models. This process covers all of the local and global asset classes that are suitable for inclusion in our multi asset class funds and model portfolios. The output of these models guide our tactical asset allocation decisions, where we under or overweight certain asset classes in the short term, compared to our longer term target weights. Let’s take a look at how our views on some of the local asset classes and currencies have changed for the year to date.
In terms of the Price to Earnings ratio, the local equity market has been extremely expensive for the whole year. The ratio has been above 21 since March, compared to the 10 year average of 15.9 and 30 year average of 14.4. Earnings have come down 16% for the year to date, and are now at very low levels versus our trend model and the Graham and Dodd average, which is an inflation-adjusted number smoothed over seven years. This is illustrated in the graph below:
Source: Seed Investments
On a sector level, we have seen significant changes in the relative valuations. Financials, weighted down by political uncertainty and the prospect of a ratings downgrade, have become cheaper and cheaper. Resources have had an excellent run this year, and the PE relative to the broader market has increased significantly.
Local bonds have remained relatively attractive for the whole year since the December 2015 yield blowout, although yields have come down significantly since. The average 10-year yield of 9.0% for the year appears attractive vs. the short term average of 8.2%, but not against the 30 year average of 11.4%.
This asset class has been very volatile for the last year, presenting the chance for opportunistic trades but requiring excellent timing. At Seed we have retained our preference to take on some duration risk in via our property exposure, where the yield can grow, rather than bonds.
The real return on cash is the 3 month JIBAR rate, which is the rate used for interbank lending, less annual inflation. The two rate hikes this year have seen JIBAR rise to 7.4%, while inflation has come down to 5.9%. As a result, cash has offered an increasing real return for the past two years, unlike the period from 2011 to 2014. Therefore, the optionality that cash offers to the multi asset class investor has become even more attractive.
Source: Seed Investments
For the year to date the ZAR has strengthened tremendously, from R15.46 to R13.72 at the end of September versus the USD and from R22.55 to R17.59 versus the GBP. Of course, these moves are partly in reaction to the severe weakness towards the end of 2015. The ZAR has now returned to the levels of a year ago against the Euro and Dollar, and is approaching the long term Purchasing Power Parity fair value vs. the GBP. History has taught us that the Rand will not necessary return to PPP fair value and stay there, but might strengthen beyond that level and stay overvalued for some time.
But how has this influenced Seed’s asset allocation decisions this year? In the Seed Balanced Fund, local equity exposure has been brought down to a 35.2% average this year, compared to the 50% benchmark weight. In addition, with the local market remaining expensive, the decision has been made to reduce equity even further.
A currency hedge was put in place towards the end of 2015 to protect our offshore exposure from Rand strength, which seemed inevitable at the time. This hedge successfully offset the negative effect of Rand appreciation in the global portion of the Seed Balanced fund this year.
We have also made increased use of cash-plus type strategies, which use floating rate instruments that yield a certain percentage above the JIBAR rate. With JIBAR increasing considerably, the yield on these strategies has been very attractive indeed.
Cor van Deventer
Tel +27 21 914 4966
Fax +27 21 914 4912
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Wed, 19 Oct 2016- 11:22