Balanced funds on average had dismal performances in 2022. And not only last year: it’s been going on for some time now.
Last year — using calculations from Fundsdata — the average of South African balanced (high equity multi-asset) funds returned all of -0.1%. The top-performing fund, the PSG Multi-Management Growth Fund of Funds delivered a return of 11.27% — not even four percentage points above inflation.
As Jonathan Myerson, head of fixed income at Visio Fund Management, explains: “The expectation of balanced funds returning more than inflation plus five percentage points has been around since the early 2000s.”
During the first decade of the century, “South Africa’s economy grew strongly and inflation was on the decline”, he says. “CPI plus five percentage points became stuck as the benchmark for balanced funds.”
Yet no balanced fund has come close to averaging inflation plus five percentage points over the past few years.
Reza Hendrickse, fund manager at PPS, says: “The scope to generate inflation plus five percentage points is quite limited in the high equity multi-asset fund space.”
To achieve this benchmark, which seems muted compared with equity funds’ performance in some years, fund managers have relied on the 60:40 principle — 60% of a fund allocated to equities and 40% to bonds.
The rationale behind such an allocation rests on how equities and bonds perform during economic cycles. In times of hardship (recession), investors typically flee into bonds as safe havens. When the tide turns, they’ll sell off bonds and use the cash to seek out nuggets among equities.
In terms of developed market bonds, the correlation between bonds and equities broke last year. The part of the market that should have protected your investment didn’t do so
— Justin Floor
But last year, the 60:40 principle fell apart, says Justin Floor, fund manager at PSG Asset Management, which holds the top and third spots among balanced fund returns in 2022. “In terms of developed-market bonds, the correlation between bonds and equities broke last year,” he says. “The part of the market that should have protected your investment didn’t do so.”
Rob Spanjaard, CEO of Rezco Asset Management, which manages one of the top 10 balanced funds in the country, shares the sentiment: “The 60:40 principle worked marvellously for many years but got murdered last year as interest rates started rising.”
It meant that both bonds and equities suffered, especially in developed markets. The MSCI all country world index, which tracks 2,933 companies, plummeted 17.96%, whereas the FTSE world government bond index, which tracks investment-grade debt among more than 20 sovereign issuers, tanked 18.3%.
The reason behind this market fright was inflation that has not been seen in a generation. “It all unravelled last year,” says Rory Kutisker-Jacobson, fund manager at Allan Gray, whose balanced fund was among the top 10 performers last year. “At Allan Gray, we’ve been concerned about low interest rates for a while and didn’t participate in the so-called hot stocks.”
Since October, however, world markets have had an extraordinary improvement in fortune. Consider that the JSE all share index is up over 9% year to date.
Still, says Spanjaard: “It’s going to be a tricky year. We think there’s a 70% chance for a recession.”
He reckons there are great buying opportunities to be had in equities in particular. “South African equities are trading at low p:e multiples whereas South African bonds are trading at attractive yields.”
For Floor, whose funds benefited from South Africa’s resilient midcap market last year, possible outperformers this year include Discovery, Prudential and AB InBev.
Myerson says US government debt (treasuries) are looking attractive with their 3.5% yields. Similarly, “domestic bonds seem OK”, he says.
Floor, on the other hand, says: “Developed-market bonds are the least attractive asset class for us. Their yields, despite last year’s correction, are still too low.”
PSG Wealth chief investment officer Adriaan Pask is also bullish on local assets. “We see value in domestic bonds and equities. No-one knows exactly what will happen over a short period of 12 months, but statistically these are the cheapest and exhibit the highest probability of outperforming.”
These sentiments may explain why none of the fund managers interviewed had maxed out their offshore allocations — adjusted upwards to 45% of a fund’s underlying assets in last year’s budget speech.
“It all comes down to the price you pay,” says Kutisker-Jacobson. “In South Africa you are rewarded for the risk you take through a real yield,” he says about local government bonds.
Floor agrees. “There are still very good opportunities in rand shares, notwithstanding load-shedding. South African companies are very resilient.” Hendrickse says “it makes sense not be maxed out due to local valuations”.
The question now, is whether the 60:40 principle relied on by multi-asset fund managers will be able to prove itself again. What is the outlook for balanced funds?
“I foresee solid returns for 60:40 funds over the next couple of years,” says Myerson. “2023 will likely not be nearly as bad for balanced funds as 2022.”
Interestingly, Myerson says balanced funds remain a good option for investors with a low appetite for volatility. “Following the 2008 financial crisis, it took South African equity funds 33 months to recover to the level before the crash. Multi-asset funds took 18 months. On average, in the decade through 2020, equity funds were 1.6 times more volatile than the multi-asset category.”
Maybe, then, these funds will regain their equanimity this year.
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