Allan Gray concerned about market valuations

Minimising the risk of loss without being conservative to the point of missing out on potential returns is an ongoing balancing act for fund managers.

Ultimately, getting this trade-off right is key to successful investing and currently the risk of loss outweighs the risk of missing out.

While we have no special ability to predict the future, we have a relatively high conviction that opportunities to invest in equities will be better in future than they are right now. Working out the balance between the risk of losing money and the risk of missing opportunity is highly dependent on the relationship between equity prices and their underlying fundamental valuations at any point in time.

Looking at the past 15 months, the SA stock market is up approximately 34% from the January 1 2009 and more than 55% since the March 2009 low.

The simultaneous re-rating of the ALSI from around nine times earnings at the start of last year to the current P/E of over seventeen times is well above the long term average of 11,5 times. Our current assessment is that the risk of loss for the market as a whole is higher than average.

This assessment is informed by three main factors. Firstly, the current high level of the market and the pace at which the market rallied last year. We believe this occurred faster than underlying fundamentals would support.

Then, there is the current valuation of the market as reflected by the P/E ratio, the dividend yield and the price-to-book ratio. Finally the current level of earnings for the market is still above normal.

Allan Gray’s asset allocation portfolios, such as the Allan Gray Balanced Fund and the Allan Gray Stable Fund, with their reduced levels of equity exposure, reflect this assessment. This is especially evident in the Stable Fund which is aimed at investors who are particularly concerned with the risk of loss over the medium- to long-term.

  • Delphine Govender is a portfolio manager at Allan Gray

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