Unit trust results over the last quarter reflect low interest in local equities Neil Thomas The sagging local equities market is inspiring some serious abuse of poor old William Shakespeare. Chief culprit is Jeremy Gardiner, head of Investec Unit Trusts. The erudite Gardiner, who regularly pens entertaining prose on the market, bemoaned the fact that terrible conditions were forcing him to discuss the weather in his last offering. Gardiner sought refuge in the classics. But his description of the Johannesburg Stock Exchange (JSE) as being in its winter of discontent was an understatement – it’s an arctic freeze, forcing investors’ funds to flee our shores for the mild yet more welcoming climes of mainly northern hemisphere markets, or the relative security of local fixed-interest investments.
A breakdown of the past quarter’s unit trust inflows tells the whole sorry tale. Of the net inflow of R6,4-billion, R2,4- billion went into rand-denominated offshore funds, R2,1-billion into money market funds and R1,1-billion into domestic bond and income funds. That implies that only R800m was invested in local equity unit trust funds, which in fact represents an outflow from these funds of about R160-million. The tragedy is that much of the outflow probably represents a loss for unit-trust investors. Those already in the local equities market should not get out now, though the trend is consistent with that local phenomenon of buying high, selling low (though how much was by actual investors and how much by intermediaries or fund managers is another question). As depressing as domestic share prices look, they are generally in undervalued territory and will come back. The question, however, is when? There are no clear answers here yet. It is also not hard to sympathise with the pessimistic view local investors have of the JSE. Over the past quarter the All Share index has declined by 2,5%, making its drop for the year so far about 9%. Set this performance against the bullish forecasts at the beginning of the year – when a number of fund managers were talking about growth of 25% to 30% – and the disillusionment is understandable. Where this trend hurts the average unit trust investor is in the performance of the country’s 45 general equity funds. Most have not even been able to contain the decline of their funds to the 9% of the All Share index – over the year so far the aggregate performance of the general equity funds is a negative 9,8%. Over the same period domestic money market funds have offered an average return of about 5,2%, domestic bond funds about 6,1%, and domestic income funds about 5,8%. In contrast, offshore funds have been stunning performers on a relative basis. The average return from the foreign general equity funds is 16% so far this year. Apart from general market conditions and Afro-pessimism inspired by Zimbabwe’s President Robert Mugabe, there are two related forces undermining the performance of equities on the JSE. One is the absence of foreign investors, in both the equities and bond markets. Much of the cheery forecasts at the beginning of the year were premised on foreign investors and the large emerging market funds returning to South Africa in a big way. This has not happened: foreigners have been net sellers since the first couple of weeks of the year. Apart from the effect this has on sentiment, it drains liquidity from the local market and, as foreign investors exit, keeps downward pressure on share prices. The impact is worsened by the strong flow of local funds into foreign unit trusts. A more buoyant domestic equities market would have attracted at least some of the R2,4- billion that went into foreign funds over the past quarter, and possibly the lion’s share of the combined R3,2-billion invested in money market and bond and income funds. So with both foreign and local investors pulling out of the equities market, liquidity is worsened and the whole process becomes a vicious, downward cycle. This combination of negative technical forces and sentiment is why predicting recovery is so difficult. The underlying macro-economic outlook does not help. Generally, there are tentative signs of recovery, with leading indicators like new vehicle sales and cement sales picking up. But overall earlier GDP forecasts have been scaled back to about 3%. And the future trend in interest rates is being debated – about the safest bet is that they will stay where they are. Complicating the outlook for the current quarter – and the rest of the year – are warnings that many of the rand-denominated foreign funds are approaching capacity and may have to close soon. Some already have, and further relaxation in exchange controls is unlikely before next year’s budget. All of which is very frustrating, because there is undeniably value on the JSE right now. The problem here, as most fund managers admit, is that choosing sectors is very difficult. Stock selection is fine for investors who have some knowledge of the market and are invested directly in shares. But that rules out most unit trust investors, who are in these funds precisely because they are more affordable than direct equity investments and because investment decisions are left to professional managers. So if the professionals are confused, where does that leave the average unit trust investor? Nearly all the specialist theme funds have underperformed, making up the bulk of the bottom 10 performers over the past year. However brave, optimistic investors with speculative cash might consider the severely down-beaten small companies and micro caps funds. Rerating might not yet be imminent, but when it does come it should be rewarding, far stronger than the market in general. It’s hard, however, to offer firm advice to new investors. Personally, I’ve always believed in equities as the best longer- term investment, but the outlook is so clouded at present that it’s no time to try and be a hero. There’s no fool like an old fool, but I’m not a fool yet so my new money will go into money market funds (and I will leave what I already have in equities and hope for recovery). At least they will offer a return over the short term that will beat inflation, if the Reserve Bank maintains its inflation targeting range. And money market funds are liquid, and can be shifted into the equities market as soon as there is clearer evidence of an upturn in the local market.