Sean Neethling

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

We did not make specific changes due to higher inflation or interest rates. Portfolio allocations are less an outcome of any macro views and more attributable to markets providing a better entry point to either improve expected returns or enhance portfolio robustness. As an example, in local portfolios, we maintained overweight positions to SA government bonds where the payoff profile remains attractive as market participants price in an especially aggressive interest rate hiking cycle. In global portfolios, we added to portfolio duration as fixed income assets that have historically had low correlations with equity markets started to offer more attractive implied returns.

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

I think the most important thing to recognise is that the distribution of potential investment outcomes has widened considerably in the current environment. Having a framework to think probabilistically around the distribution of those potential outcomes, paying attention to portfolio robustness and stress testing our forward-looking risk-adjusted return assumptions were parts of our existing investment process we increased focus on.

In what ways have markets surprised you this year?

This year has seen a convergence of tail risks all playing out at the same time. The Russian invasion of the Ukraine, zero-Covid policies in China and unprecedented levels of global inflation are specific risks which continue to shape investment outcomes in the current market environment. The general drawdown in asset prices following these events was not especially surprising given the level of excesses that have been building up in capital markets. However, the breakdown of correlations between traditional asset classes, as well as those assets that have historically provided some downside protection during periods of extreme market uncertainty, is somewhat outside our normal range of expected outcomes.

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

It’s potentially too early to make inferences from market swings over the past two years. Asset prices tend to fluctuate more due to investor sentiment in the short term. Focusing too narrowly on those experiences could introduce a recency bias that is not necessarily consistent with how markets can be expected to perform over the long term. Widening that lens over a longer period probably provides a more useful framework for assessing the fundamental drivers of returns and the extent to which cyclical or structural shifts are captured in asset prices.

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

The changes to Regulation 28 allowing offshore allocations to be increased to a maximum of 45% attracted the most debate. The purpose was to consider the extent to which we could revisit long-term asset allocations and improve the robustness of portfolios by reducing home bias to a shrinking SA equity opportunity set. Those discussions were not only focused on the underlying asset class allocations but also on appropriately managing the foreign currency volatility that comes with higher offshore exposure. Another important consideration was reviewing the suitability of higher offshore allocations for the specific objectives and constraints of target risk portfolio mandates.

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

Increasing global exposure in higher-risk SA local portfolios allowed clients invested in those mandates to benefit from the currency effect of a higher allocation to US dollar-denominated assets. That capital was invested offshore at attractive exchange rates that have translated into meaningful gains as the US dollar has continued to strengthen over the year. Client portfolios also benefited from overweight positions in SA equities spread across broad-based market beta and more differentiated active share positions. Higher allocations to SA resources delivered exceptional returns and provided a hedge against drawdowns experienced in global assets during the first half of the year.

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

From the perspective of a local multi-asset investor, asset prices are cheaper but prospective returns can be expected to come with increased volatility. Despite SA valuations being attractive the potential range of outcomes is relatively wide in the short term. While valuations on most global assets are still not especially compelling, the recent changes to Regulation 28 have increased the ability of fund managers to more meaningfully size offshore exposure to mitigate home bias in local portfolios. Combining hard-currency foreign assets with cheaper rand-based domestic assets offers diversification benefits that are largely uncorrelated with idiosyncratic SA risk. This has allowed us to construct more robust long-term portfolios than we were able to do at the end of last year.

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

I think those interactions where managers have fundamental views that differ from our own are the most appealing because they allow us to revisit our existing thinking. The conversation around the next 10 years looking distinctly different from the previous decade is especially interesting given the possible asset-pricing and risk-management implications. Structural change is often particularly challenging to value, so paying attention to any fundamental shifts across our investable universe could potentially provide an additional lens to consider the market dislocations being experienced today.