Fatima Vawda

The big themes in markets this year were rising inflation and interest rates. How did you respond in your allocations?

Entering 2022, we knew that inflation and monetary policy normalisation were going to be the primary drivers of market sentiment. However, we didn’t foresee their severity. We did not expect inflation to hit close to 8% in SA and 9% in the US. When one of our external strategists projected in February this year that SA inflation would peak at around 8%, we took it with a pinch of salt. Similarly, we did not foresee a scenario where the Federal Reserve and the SouthAfrican Reserve Bank would deliver 75 basis point hikes in consecutive meetings. Bond yields have also spiked beyond what we thought were ceilings.

We pivoted our portfolios as we received confirmation that we were entering an economic regime of high inflation, high interest rates and sluggish economic growth. At the asset class level, we cut back on risk assets. We made a tactical exit from SA property and deployed the proceeds to income funds.

However, most of the action was on the blending of the building blocks. In equities, we cut back on interest-sensitive assets with high valuations in February and March. This skewed the portfolio towards value funds. More recently, we started topping up our quality managers in anticipation of margin compressions for companies as the impact of inflation and high interest rates kick in. We are also closing our long-held underweight position on global bonds; the focus being on short-term sovereign bonds, corporate bonds and Africa bonds.

How have some of the major geopolitical events we’ve seen this year influenced your decision-making?

They worsened macroeconomic headwinds that the market was already facing. For instance, the Russia–Ukraine war fuelled global inflation and the recession in Europe.

In the greater scheme of things, Russia’s invasion reminded us of a lingering risk that the market often overlooks. As a result, for most emerging assets, our risk threshold has increased; we now demand a higher premium for geopolitical hotspots such as the Pacific Basin. We are also looking beyond geopolitics. Other fissures, such as deglobalisation and economic wars, are emerging and must be monitored closely. 

In what ways have markets surprised you this year?

As highlighted above, most of what happened was unexpected. That said, the extent of volatility in bond markets and the subsequent selloffs top our list. Bonds, particularly investment grade sovereigns, are often viewed as havens with low return variability. This has not been the case: the asset class sold off aggressively for most of the year with never-before-seen daily movements in yields. The Barclays Global Bond index entered bear market territory for the first time since its inception in 1990. We also didn’t anticipate the strength of the dollar.

On equities, we think a correction was overdue. But again, we are surprised by the depth of drawdowns in some segments of the market.

How did the lessons of 2020 and 2021 help you in 2022?

2020 and 2021 were marked by a massive dislocation between valuations of assets and fundamentals both in bond and equity markets. Exuberance in the markets and access to cheap money contributed to the unprecedented inflation of valuations, especially for growth names.While we were aware of this, we didn’t trade on the valuations theme on time. The big lesson for us is to pay more attention to fundamentals and not be afraid of making contrarian moves when necessary. We are busy developing models to play behavioural biases in markets.

2020 and 2021 also taught us that when it comes to equity investing, styles are important. Well-balanced funds tend to fare better than those with style concentrations.

Speed of execution is of prime importance. Fund managers must be flexible and act quickly on asset allocation decisions.This may mean prioritising liquid assets in the portfolio.

Which asset allocation questions have been most hotly debated this year in your team?

We agreed that we needed to be defensive in our positioning. However, we were divided on the question of offshore versus local assets. It was a question of valuations versus earnings outlook. SA assets were sitting on the cheap side of the valuation spectrum, but the earnings outlook is murky.Global equities, on the other hand, offer a large pool of quality names with much stronger earnings outlooks but are not cheap. The decision is complicated by an uncertain exchange rate between the rand and the dollar. We eventually settled on an overweight allocation to offshore assets. While the decision worked out in some months, it hurt us in others. The recent decline in valuations of offshore assets has tipped the votes in their favour. 

What decisions have you made this year that have had the most impact on your portfolios?

Portfolio engineering. Skewing portfolios towards value managers and reducing exposure to growth. Both growth and value have sold off, but value was a bit more defensive.

Exposures to alternatives also helped cushion our portfolios against the selloffs. One of the global hedge funds we picked at the beginning of the year is currently sitting on an alpha of more than 30% relative to the MSCI World.

Do you believe that the investment landscape for South African investors is more or less attractive than at the end of 2021?

We believe that the recent sell off in offshore assets, which has seen some of the high-flying tech companies spot PEs in the mid-teens, has created a much-needed buying opportunity for long-term investors. We see more opportunities now than in 2021. We have since upgraded our medium-to long-term return expectations for global equities. While we know that the short term will be bumpy, we see high potential returns from some of these assets over the long term. It’s a rare opportunity, particularly for newer investors who were previously deterred by the high valuations.

On the local side, conditions have deteriorated. SA’s GDP outlook has been slashed significantly as the economy is poised to enter a technical recession this third quarter due to internal and external factors. Electricity load-shedding continues to hamstring efforts to resuscitate the economy.The political environment has also become toxic, with the possibility of dysfunctional coalitions after the 2024elections. The weakening in commodity prices coupled with the avoidable strike by Transnet bodes ill for the fiscus. These work against the investment case for SA-facing assets.

What are the most interesting conversations you have had with asset managers this year?

The recent increase in the offshore exposure limit to 45% from 30% dominated discussions with balanced funds’ portfolio managers. Most managers are not increasing their offshore allocation primarily due to the fear that such moves would increase portfolio volatility.

The invasion of Ukraine also put a lot of funds’ risk management frameworks in the spotlight. It was interesting that managers tightened their risk limit frameworks on geographical exposure to markets with controversial governance.

Sustainability also took centre stage as climate change was top of the agenda.