Tavonga Chivizhe

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

BIP follows a macro-regime-driven asset allocation process. Strong business cycles mean we increase exposure to risky assets such as equities, commodities, infrastructure and real estate. Weak business cycles bias us towards lower-risk assets such as cash and bonds.

The backdrop of rising inflation gave birth to synchronised monetary policy responses against inflation by nearly all global central banks, with the Federal Reserve the most aggressive.

This resulted in the US yield curve inverting – meaning the cost of capital needed to run an economy was raised to levels above what most economic participants can afford. Empirical evidence suggests that 80% of the time this has occurred since the early 1900s, economic and earnings recessions have occurred.

On this basis, we shifted into a capital-preservation mode and reduced our growth assets exposure materially in favour of SA fixed income.

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

By geopolitical risk, we refer to wild-sized moves in markets that are usually caused by highly unforeseen and largely unpredictable policy, political or geographical events, which impact portfolios adversely.

To navigate this we express a bias towards capital protection across our strategies.

2022 was very stressful for decision-making in this regard because the valuation risk for historically cash-preserving asset classes was largely unfavourable:

• Defensive asset classes such as developed-market equities, developed-market bonds, developed-market cash and SA cash started off the year at extreme overvaluation when compared with far less protective asset classes such as emerging-market equities, SA equities and SA bonds.
• Typically defensive equity investment styles such as growth and quality were not favourable relative to less-stable investment styles such as value and small and mid-caps.
• The defensive US dollar started off the year with extreme overvaluation relative to less-protective currencies such as the ZAR.

Against this backdrop of extremely overvalued defensive investment opportunities, it was difficult to implement capital-preservation investment decisions as nearly all the typical hiding places carried excessive adverse valuation risk and consequently suffered huge losses.

In what ways have markets surprised you this year?

The battle between investors and policymakers has been extreme, despite conventional wisdom cautioning investors not to fight the Fed. Each time the Fed proved its resolve to tame inflation regardless of weak economic growth numbers, markets sold off across the board.

Each time weak economic growth numbers were released, markets rallied, hoping this would force the Fed to start cutting interest rates. This battle continues to cause extreme volatility and the biggest concern with this is that, beyond a certain level of volatility, financial accidents which carry systemic risk are triggered.

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

A key lesson is the importance of having a sound investment philosophy and process that must be reflected in every investment decision we make regardless of market and economic uncertainty.

2020 tested our ability to rerisk our portfolios as the risk of a recession dropped materially. 2022 has tested our willingness to derisk our portfolios as the risk of an economic recession increased.

We followed the process and implemented accordingly in both instances.

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

• The onshore versus offshore allocation decision. Traditionally, offshore allocations are more defensive than onshore allocations. But this year the valuation risk of asset classes and currencies has been significantly skewed against offshore opportunities. We have reflected this with a 10% overweight onshore assets classes in SA fixed income.

• The US dollar. Our team agreed that, despite very expensive valuations, the dollar would strengthen further, possibly for longer than we could estimate, which made it difficult to reduce our exposure. Due to overly extended valuations of the dollar, and meaningful downside risk to our offshore carve-out if the dollar weakened, we reduced our allocations in favour of local assets.

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

• Reducing overall growth assets exposure after the inversion of the US yield curve in May. This has added value as growth assets have sold off further since we made this call.

• Reducing offshore exposure in favour of onshore exposure due to superior valuations locally. In ZAR terms this has not added value due to the relentless strength of the US dollar, which benefited offshore assets more than local assets.

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

Our investment philosophy is of the view that, regardless of valuations, market prices follow earnings growth.
• In strong business cycles, earnings growth has stronger support and this benefits market performance.
• In weak business cycles such as today, earnings growth has less support and this drives low to negative market performance outcomes.
• And within this context, all else equal cyclical geographical regions such as China, Emerging Markets, South Africa and Japan tend to have a much worse weakening in earnings than non-cyclical geographical regions like the US.

For South Africa, our process indicates that it has superior valuations to all of the above geographical regions.

For 2021, when the global business cycle was stable to strengthening this meant that South Africa was superior to offshore ideas. For 2022, when the global business cycle is weakening with a higher probability of an economic recession, this is less obvious.

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

Key this year are:

• Impact of rising bond yields on defensive investment styles such as growth and quality.
• How to assess a peak in bond yields or a bottom in equity prices.
• Portfolio positioning amid increasing economic recession risk.
• Implications of investing amid resilience in the strength of the USD$.
• How South African managers will cope with the significantly increased allocation to offshore assets of 45%.
• Can China’s policy stance be a wildcard that protects global economic growth as was the case in 2008-09?