You're listening to Strictly Business Podcast with Lindsay Williams.
91 believes it's time to rethink what cautious really means.
With me to explain this is Sumesh Chetty, Portfolio Manager at 91 in Cape Town.
Now, Sumesh, I think it's appropriate that we look at cautious.
Before we rethink cautious,
let's think cautious and what it is in a South African context and what you mean by
cautious.
Please explain.
Okay, thanks, Lindsay.
So what we mean by cautious may not be what everyone else means by cautious.
So let's start in its most basic form.
Think bank accounts.
So an individual might put money with a bank, a first-rand or a standard bank,
whatever the case may be, and somewhere between 2% and 5%,
depending on how long they're willing to lock their money up for.
You could then move into a money market fund from one of the asset managers, like
91%, and you'd earn another 1% to 2%,
maybe even 3%.
And what's become very popular over the last couple of years is, of course,
diversified income funds.
And that adds a little bit of credit risk to your money market type funds.
You can have a little more duration as well and you can get another, let's say,
1% to 2% pickup.
And this has been massively beneficial for investors over the last many years in
South Africa
because interest rates, the South African Reserve Bank has kept interest rates very
high relative to inflation.
And there was almost a freebie to be had,
given that there's been so much concern around the South African environment, our
government.
There's been a risk premium built into our fixed interest instruments.
Now, that would be, let's say, amongst the most conservative of funds.
But of course, also in the South African landscape,
we've had multi-asset low equity funds that are cautious funds.
And those low equity funds can invest up to 40% in equities.
And why have equities historically been very important?
You know, it's the one way to ensure that you outperform inflation over very long
periods of time.
OK, where are we at the moment when it comes to real yields in South Africa?
I'm very simple.
I look at the South African 10-year at, say, 9.6%.
I see inflation, which has just ticked up recently to 3.5%, but was below 3%.
That's pretty healthy, isn't it?
That's phenomenally healthy.
at 6%.
But the problem that we have is the Reserve Bank is targeting inflation at the
bottom end of the range
now.
So we have an inflation targeting range of 3% to 6%.
Historically, we thought about it as the Reserve Bank wants to end up at about
4.5%. But the governor has come out and said, look, they're targeting the bottom
end of the range.
They want to be at 3%.
Now, we can debate for a while how you get to 3%.
percent But I would say the bank is very lucky in that there isn't a lot of demand
pull
inflation in our economy right now.
What I mean by that, the consumer's on its knees.
There's not a lot of demand for product because people, well, you don't have a lot
of money in your wallet right now,
but we're struggling as a society.
And that lack of demand, I think, has kept inflation on the low side.
And we've also benefited from lower oil prices.
and a relatively flattish rant, volatile but flat over the last five years.
And of course, it's strengthened on a year-to-date basis.
And what that means is with lower inflation, if the Reserve Bank thinks that
it's sustainably low,
interest rates are going to be cut.
Interest rates are going to come down.
And you'll probably find they'll come down at the short end.
And they'll also impact the long end of the curve or the 10-year point of the
curve.
And that'll come down as well.
Now, Those higher rates have been massively beneficial to investors because
they're giving you that strong real yield.
But the next 10 years aren't going to look like the previous 10 if you see those
interest rate cuts.
But more importantly, in an environment where those interest rates come down, both
at the short end and the long end,
that decline in interest rates actually makes risk assets, or specifically
equities,
far more attractive to investors.
So you may well find that at a particular level, interest in the
SA equity market increases significantly.
Why is this important?
If you are investing in a, let's say,
traditional cautious product or a cautious product that is only invested in fixed
income
instruments or in money market instruments, you are potentially leaving
returns on the table,
returns that will emerge from the equity market.
When people think about cautious portfolios, they think purely in terms of
capital preservation.
Some investors also think about that inflation protection, and they've
benefited, as I said earlier, from what's happened over the last 10 years,
because a pure money market investment has done both.
But going forward, we're arguing that isn't necessarily going to be the case.
And what matters is not just the fact that you're making a positive real return.
The quantum of the real return matters.
Because if you think about things like...
Medical aid inflation.
Think about people who are retiring and you've got a medical aid that you have to
pay.
Premiums are going up by more than inflation plus one.
They go up in the order of inflation plus three, inflation plus four.
So what you're saying is inflation is not for everybody.
When I say, for example, three and a half percent, no, it's really not.
Medical inflation and food inflation might be outperforming the benchmark of three
and a half percent.
Correct.
So, I mean, someone looking at their basket of groceries, you're not
experiencing three and a half percent.
You know, that basket or the CPI basket is meant to be representative for society as
a whole.
But for any one individual, it doesn't necessarily apply.
And I think people or investors specifically have to be very careful about
that.
So if you are focusing purely on the type of investment that gives you a real
return,
but.
isn't necessarily going to give you the threshold of real return that you require.
You may not be sitting in the type of cautious portfolio that you thought you
were, because capital preservation is one thing,
but you've also got to maintain your real purchasing power.
All right.
So what we're saying here is interest rates might fall in South Africa.
It's highly likely that they will.
And when rates fall, it benefits equities.
It benefits growth assets.
Growth assets, exactly.
I like this sentence that came in a piece that one of your colleagues kindly sent
me.
It says the following, too many conservative portfolios are built for the
last cycle, not the next one.
Do you mean that portfolio managers have this degree of inertia where they hold on
until it's too late and then they, as you say,
leave some profit on the table?
I don't think that, strictly speaking, is the case.
I mean, there might be the odd individual who has that.
backward-looking buyers.
But I'd like to think on the whole, portfolio managers are forward-looking
creatures.
But I think what you might find is that investors anchor to what's worked in the
past.
And only when you see the inflection point do you actually want to make the change.
On average, I would always argue that portfolio managers are forward-looking.
So you've just got to be very careful when you as an investor start thinking about
the environment.
Because you've done exceptionally well in an investment historically, it doesn't
mean it's going to continue
into the future.
And I think we're at a particularly dangerous point right now, because if
interest rates come down,
the investment you are holding is actually still going to continue to do well as
those interest rates come down.
But there's an opportunity cost, because while that's happening, there might be far
greater gains to be made elsewhere.
So you have to weigh that up.
You've got to be very careful, because once those interest rates have fallen,
you've effectively locked into that much lower rate going forward.
and potentially missed out on the initial set of gains that you would have made on
risk assets.
So what we're always arguing is the real nature of equities is critical in a
portfolio where you want to
preserve capital in real terms.
So you've got to look at that 40% allocation that you spoke about and you
should be utilizing that.
Let's look at the strategy of your fund, the cautious managed fund at 91.
Where are you at the moment?
How are you positioned?
So 91 cautious managed fund as i said allows you to invest up to 40% in
equities.
So we're currently holding about 31 to 32% in equities.
But importantly, we're still utilizing those very high real yielding government
bonds and money market
instruments that you mentioned.
So we've got about 34, 35% sitting in government bonds.
We hold some inflationary bonds, about 5% of the portfolio.
We have about 6% sitting in credit and um we probably sitting with around 15%
in cash right now, taking advantage of those real yields while they exist.
But one of the things that obviously on our mind when it comes to equities,
valuations and the potential for growth.
So there are opportunities out there.
You have the ability to take these opportunities.
But forefront on our mind right now is the fact that you're in this environment where
the cost of capital is
potentially decreasing in South Africa.
One of the things you have to be very careful of.
is that people might become incredibly bearish about the environment.
And it's easy to see why when you are not experiencing growth,
when you see what's happening in terms of the decisions that are being made by our
government.
I mean, we're on hopefully a positive trajectory, but there are hard yards ahead
of us.
But what has also swung in South Africa's favor to an extent,
and you see this most acutely when you look at the RAND dollar exchange rate,
is that there's a lot of uncertainty.
around the U.S.
and what President Trump is doing when it comes to tariffs attacking the
independence of the Fed, their central bank.
Sorry to interrupt you.
I was going to say, I'm going to play devil's advocate here.
It all sounds very nice.
The South African Reserve Bank has targeted 3%, and although it's 3.5% at the
moment,
they are a very august institution, and they should be able to manage around 3%.
What if they can't?
What if inflation in the United States and the rest of the world.
starts to go?
What if the Rand dollar exchange rate starts to go from wherever it is 750 to 18
up to
19 to 1950?
What if, and some people are saying this, there's a breakdown in the US bond market?
I mean, 30-year Treasury bond has recently breached 5%. Okay, that's just the long
end.
The short end is not so bad.
But what if these things happen and your projections don't quite work out?
Are you nimble enough to take advantage of whatever is facing you?
Well, to answer your second question first, yes, we're nimble enough to take
advantage of the opportunities as they arise.
But coming back to your first question, if those things were to happen,
it becomes more supportive of the South African environment.
Because remember, if those yields rise in the US, it's because capital is moving
elsewhere.
And capital typically will look for either growth or it will look for valuations.
And the one thing we do have on our side to an extent are valuations,
because we have these elevated risk premiums that sit within South Africa.
So that will work in our favor, even though we don't have growth.
If we were to get growth right, I don't know, five years from now or 10 years from
now, that would potentially be a second tailwind.
But let's ignore growth because we don't think there's going to be any growth in
this country in the next five years, in the next 10 years easily.
So the U.S.
very much plays into your hands if you think about what Governor Lissetra is
doing.
If you see elevated inflation across the world and somehow that actually impacts
South Africa as well,
the real rate that we have, the real rate that the RASAB has imposed on us, as
you've already mentioned,
is sitting close to 4%.
That is an incredibly high real rate that actually impairs the ability for the
economy to grow.
You know, that actually hurts consumers.
So we're already in an environment where Governor Lesetra is sitting with those
high real rates to combat inflation that
just isn't there.
Interesting.
It isn't there at the moment anyway.
So you're optimistic about the future and that sort of doomsday scenario that I sort
of briefly sketched out of things happening elsewhere,
meaning that the South African Reserve Bank doesn't cut rates.
That's just speculation from a commentator.
A hundred percent,
because we don't build portfolios on a top down macro prognostication or any kind of
like.
forward-looking view where we think maybe this happens, maybe that doesn't happen.
It's always bottom-up.
We follow a quality philosophy.
We want predictable cash flows.
We think hard about whether those cash flows are going to be growing in real
terms.
So we aren't in any way advocating for someone to position a portfolio for a
particular outcome.
What we're saying is there are opportunities that are very visible to
investors today.
And what worries us a little bit is investors might...
still be focusing on what happened in the past and believing that will continue to
happen in the future.
Sumesh, thanks so much for your wisdom.
Sumesh Chetty is a portfolio manager at 91 in Cape Town.
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