Cranes, planes, and rock and roll may on the face of it seem like they don’t quite fit into the world of hard-core investments, but you may already have them in your portfolio. What are they doing there?
Against a backdrop of lower returns for longer, asset managers have been forced to venture ‘off the beaten track’ in search of alternative sources of returns, along with a greater focus on risk management, in constructing optimal, well-diversified portfolios.
Lower GDP forecasts mean lower returns going forward
We are living in challenging times and SA’s GDP is expected to be even lower than the recently lowered global GDP forecasts. This is a difficult scenario for portfolio managers as lowered GDP forecasts translate to lower company earnings. The result? Lower future returns from traditional asset classes. The dovish tilt of the Fed gives us some hope, though. Still, the past 10 years’ global tailwind may be coming to an end.
There are also other factors at play, for example demographics, that are putting downward pressure on future earnings. We expect the downward shift in returns relative to risk to be more pronounced in higher-risk assets (i.e. growth assets such as equity and listed property). Saying that, there is still a case for holding a substantial chunk of your portfolio in higher-risk assets. If you look at the Top 40 on a bottom-up basis, and build up a forward P/E for these 40 stocks, you’ll see a number of the Top 40 stocks are trading at a discount to fair value. To be able to extract maximum benefit from these fundamentally-driven valuations, being an active stock picker is therefore important, as there is value to be had – value that an active stock picker is mandated to identify and exploit when constructing a portfolio.
Aiming for the highest possible return per unit of risk
There is more to future returns than only the long-term average that can be achieved. Different assets achieve returns with varying levels of volatility and uncertainty and, on a practical level, the level of ‘choppiness’ with which a portfolio achieves its returns matters to investors.
With such a wide range of possible year-on-year outcomes per asset class, as portfolio managers we make sure that we build enough stability into the portfolio, so that when we have a sub-optimal return in any asset class, there’s plenty of built-in inherent protection to rely on.
A toolkit for stability
There are numerous tools available to bring more certainty to the return outcomes of your portfolio.
- Playing the long game
This is one of the components of investing that lies within the control of the investor. If you’re able to sit out a market slump, asset class performances should eventually return to their long-term, expected averages.
Various studies have proven that broad diversification gives investors a smoother return journey. As the portfolio manager of absolute return multi-asset funds at Sanlam Investments, I have one of the most diverse toolkits in the country to build outstanding portfolios. Outside of the traditional asset classes of equity, bonds, property and cash, we also have derivatives, portable alpha and various alternatives including real assets to choose from.
Back to the planes, cranes and rock and roll topic of this article. The cranes refer to our real assets, physical, tangible assets. They are defensive in nature, i.e. less sensitive to the economic cycle. The planes refer to aeroplane investments that is being rented out to some well-known, credible airlines, where the risk sits with the airlines and the manufacturer, and on which we’re getting yields of close to 8% on average. These assets are on the Sanlam Investments UK platform. And rock and roll? Well, we also own music rights in the offshore space, where we target a yield of 5.2% - a relatively predictable and long-term stable source of returns in the portfolio.
As fund managers we use unconventional assets to get access to uncorrelated sources of returns, so we can push out the efficient frontier, providing higher returns per unit of risk taken. Within any portfolio construction framework, protecting the downside is very, very important, and the compounded effect of doing so should never be underestimated.
- Tactical asset allocation
The third tool in our toolkit is tactical asset allocation. Put simply, this means being nimble and opportunistic where necessary and where valuations permit. In South Africa we’re fortunate in that our markets are fairly deep/liquid. Where we see opportunities, we are able to move with agility. But a high level of skill is required to get this right.
As a practical example of what nimbleness entails for us, we really sweat the assets within our short-term interest bearing component of the fund ensuring the best possible yield without compromising on credit quality. Here we leverage off the solid credit capability of the Sanlam Investments Group. Being large gives us an information advantage in this space and we use our internal liquidity within the Sanlam Group - every basis point of return counts! As a result, we currently have high quality credit instruments in our portfolio at attractive yields boosting short-term returns at exceptionally low levels of volatility.
With our comprehensive tool box and access to various in-house teams with expertise, we are thoroughly able to deliver enhanced risk-adjusted returns. We are particularly proactive in terms of how we use protective strategies. As we go into a low-return, more volatile environment, we need to look at new sources of returns other than just the traditional asset classes, and also at uncorrelated sources of return. Investors need more certainty of returns. Other than proactive explicit downside protection, a true broadly diversified portfolio – even pushing the boundaries with planes, cranes, and rock and roll – is the surest way we can meet this need.