- 31 October, 2022
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The domestic and global markets are awash with volatility but stay the course as the storm will pass.
There is understandably a fair amount of concern and uncertainty regarding the current state of the financial markets and the negative impact on investment portfolios in 2022. There are many moving parts to the unfolding situation, and it is imperative that we make informed and unemotional decisions to ensure that we remain committed to our long-term advice and investment strategies.
The Adviceworx Investment Committee meets constantly to discuss, debate and ultimately make tactical portfolio decisions that we believe are in the best interests of all of our clients invested in Adviceworx strategies. In the current volatile environment, we remain aware to the fact that we need to remain responsive to global market shifts at short notice and as such the investment committee is constantly alert to any significant changes with all members connected daily.
One of our key objectives is to provide our clients with the peace of mind that we are alert to the volatile shifts and factors influencing both global and domestic capital markets and currencies and we will not hesitate to take responsive action at short notice.
We need to provide clients with the assurance that your Adviceworx portfolios resemble our best investment view and that we will implement changes that we feel are appropriate to these portfolios timeously. Equally so, it is imperative that we share these insights with you so that you are kept informed and are assured that we have all hands-on deck in keeping our strategies relevant for the times we live in.
We are crafting a series of communication called – Navigating the Storm – that will provide you with a deeper insight into the ‘behind the scenes’ deliberations and positioning decisions. We will run this series on a bi-weekly basis, until some calm returns to the markets.
Let’s take a closer look at our current investment reality:
Several headwinds have gathered momentum this year, resulting in a near perfect market storm. Global inflation has reached levels not seen in 40 years. Initially central banks in developed markets were slow to respond but are now having to play catchup. The Federal Reserve is aggressively increasing interest rates, pushing the dollar to its strongest level in more than a decade. Geopolitical risks have intensified the storm, as countries seek to diversify their supply chains and secure safe and reliable energy supplies following Russia’s invasion of Ukraine.
Now a new tempest has spooked the market and that’s the risk of recession. Markets are sceptical that the Fed will be able to tame inflation and engineer a soft economic landing because part of the current inflation crisis is due to supply deficiencies. Raising interest rates is a rather blunt tool to tame inflation if only to create a significant demand deficiency to bring demand and supply back into balance. Inducing a demand deficiency could result in recession. Certainly, the risk of policy error has never been greater, and the Fed has reiterated that it is prepared to impose pain by way of higher interest rates to temper inflation. This year, the Fed has increased interest rates from near zero to a range of 3% – 3.25% and it is widely expected that there will be another 0.75% increase in November.
Global equities which are sensitive to the level of interest rates have taken the brunt of the financial storm, down 25% in USD to end September and are now officially in bear market territory. Pockets of stress are appearing in the credit and treasury markets. Britain’s bond market for example is in disarray because of opaque derivatives used by its pension funds. The Bank of England has had to step in to stabilise its bond market.
Good news is bad news
The markets have become very choppy, reacting quite violently to economic news. Good news has become bad news and vice versa. For example, last week’s US labour report showed a decline in the American unemployment rate which in ordinary times would be digested by the market as good news. However, a shortage of workers is putting upward pressure on wages, so amid this storm, a favourable labour report is seen as bad news as it suggests the Fed will continue with its interest rate tightening cycle. Wild swings in the market in response to almost every data release has created a huge amount of noise and can be difficult for even the most seasoned investor to interpret.
Stay the course as the storm will pass, they always do
Being caught in a market storm can leave investors feeling rather queasy and understandably anxious about how much more their investment portfolios can fall in value. Storms do pass, as do financial and economic storms. In the case of the former, the evidence is clear: blue skies return, water subsides, and stillness descends. In the case of the latter, unfortunately, we don’t ever know until well after the fact. What makes it even more difficult, is that markets anticipate improvement, and therefore can rally even while things look dire. This is bound to be the case this time too, though we have no way of knowing when. What we do know is that missing out on such recovery rallies is detrimental to long-term returns. Therefore, the adage of “time in the markets, not timing the markets” remains true though always easier said than done.
Previous crises such as the Global Financial Crisis and the Covid 19 market collapse have demonstrated that the best course of action is to stay the course and stick to the investment plan your Adviceworx adviser has crafted for you. Avoid selling your portfolio now and locking-in investment losses i.e. selling your portfolio at a low point in the market. A prudent course of action is to exercise patience, ride out the storm, trust the investment professionals to take the requisite actions in response to changing circumstances to position your investments for the storm and let your portfolio recover over the course of time.
Adviceworx investment response to the current storm
Underweight international equities going into the storm
In the 2022 SA Budget Speech, a far-reaching amendment was made to the permissible limits to offshore investments within retirement vehicles such as pension, provident, preservation and retirement annuities. The increase in offshore limits from 30% to 45% offered South African investors access to a much broader universe of investment securities which we believe will result in better risk-adjusted returns for our clients over time.
Following these regulatory changes, Adviceworx reassessed its strategic asset allocation weights across all its investment solutions. The outcome of this process suggested that an optimal asset allocation in our high equity balanced solutions which target inflation plus 5% was a total offshore weight of 41%.
After an evaluation of global markets following these regulatory changes, we elected to not increase our offshore exposure at this point as the backdrop for global equities had become more challenging given rising input costs, higher interest rates and the risk of central bank policy error. Going into the storm, Adviceworx held a very significant 10% underweight position to international assets.
While the markets have already discounted a fall in earnings, the risk of more downgrades has increased which we expect will keep equity prices under pressure. While global equity markets have become cheaper, we believe the risks are weighed to the downside in the short-term, underpinning our underweight position to international assets including global equities and bonds despite the new 45% offshore limit. We will continue to reassess our underweight position as market conditions evolve and will look to deploy our cash reserves into cheaper international assets in time.
De-risking domestic fixed income
Over the last few months, we have de-risked our more conservative solutions by reducing our bond exposure in favour of enhanced income. While SA government bonds offer very juicy double-digit yields, they are fixed coupon instruments which means they are sensitive to changes in interest rates i.e. when bond yields rise in anticipation of rising interest rates then bond prices fall. This introduces unnecessary volatility in your portfolio. Our enhanced income investments still offer attractive yields of approximately 7% but with far less risk.
In our more aggressive solutions, which target inflation plus 4% and are designed to withstand greater levels of volatility over a longer time horizon, we have retained our domestic bond positions. While bonds can be volatile in a rising interest rate environment, South African bonds are very cheap relative to their developed market and emerging market peers. The bonds in our solutions are yielding approximately 11%, which makes for an attractive return when equity markets are falling.
In conclusion
Rest assured that the Adviceworx team is acutely focused on the markets, engaging daily with one another, our portfolio managers and with external experts and fund managers, both here and across the globe.
Should you like to discuss any of the changes and/or review your investment portfolio, please don’t hesitate to get in touch.
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