Cautious optimism is the name of the game in 2013

John Kinsley

John Kinsley

After a surprisingly good year in 2012, investors should be careful of being overly optimistic or greedy in 2013.

John Kinsley, MD of Prudential Unit Trusts, cautions against over optimism and projecting the past year’s returns into 2013. He explains that history has shown that the ‘good times’, whether expected or not, provide a cushion against bad times and investors should act accordingly when making investment decisions.


2012 equity performances were far better than expected

Kinsley says that the past year’s returns were a positive surprise because 2012 was expected to be dominated by risk. The FTSE/JSE All Share Index (ALSI) gave a total return of 26.7% for the year, with industrials up over 40%, driven by consumer stocks in particular. Financials were up just over 38%, but resources lagged with a return of just over 3%. Even defensive assets such as inflation-linked bonds rose by 19% over the year. Offshore, the German Dax was the top performing developed market up 37%, with the US S&P 500 up 16%.

Cash was the only laggard in 2012

Many leading asset managers were committed to either defaulting to cash or increasing their weighting in cash. In contrast, Prudential stuck its neck out and categorised cash as the least attractive of all the asset classes. “We said that we’d rather diversify into listed property, corporate bonds and inflation-linkers in our more defensive portfolios,” says Kinsley.

“Happily, that was the right decision. One consequence was that the Prudential Inflation Plus Fund, which was well endowed with these asset classes, generated 19.7% for the year. Cash, in contrast, yielded just over 5% and was negative after allowing for inflation.”

Prudential cautions retirees against increasing their standard of living after the past year

Prudential’s biggest concern is that the typical retiree will be tempted to increase the drawdown of their living annuity by an amount higher than inflation, based on the strong market outperformance.

“Whatever you do, have the discipline not to be greedy. These kinds of windfalls should be used as a cushion for periods of market consolidation such as the 2007-09 period,” says Kinsley.

“You can never know when the next period of consolidation will emerge again. If you’re able to, don’t increase your drawdown in good times to match your windfall, but rather stick to the discipline of increasing only by the equivalent of the inflation rate. This means your drawings will keep pace with inflation, but your remaining capital is allowed to develop a cushion for periods when you really need it.”

What to expect in 2013?

While Prudential don’t make predictions, they do however take a view based on current values relative to long-term equilibrium valuations. A snapshot view is that global companies are significantly more attractive than global fixed interest or cash and any South African asset class.

Developed Europe is more attractive from a straight valuation perspective. Kinsley notes that the potential break-up of Europe still remains an issue and a long period of debt reduction still lies ahead. However, the patient investor may be well rewarded.

In China, a soft landing, in other words, reduced growth without contracting the economy too severely, seems to be unfolding with growth of 8% being a real possibility in 2013. “A Chinese recovery should be good for commodity-driven economies such as South Africa,” he explains.

South African equities offered fair value for most of 2012, but have now moved to be slightly expensive. Industrials appear more expensive than financials and resources, with the consumer sector having run particularly hard.

Kinsley says that cash is currently unattractive because of its negative real yield after inflation. He explains that Prudential is more comfortable with the real yield pick-up in corporate bonds and listed property in spite of them looking slightly expensive relative to their own long-term equilibrium levels. This relative valuation between asset classes will continue to play an important differentiator in 2013.

“Don’t assume past returns will continue into the future. Past performance is not necessarily repeated. Our view on asset class valuations at the start of 2013 is that global equities are more attractive than South African equities. When looking at local asset classes, the relative real yield after inflation differences will be the key to decision making,” he concludes.

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