A simple, quantitative view of the future

By Staff Writer

A simple, quantitative view of the future.

From Allan Gray

We have cautioned for some time that future real returns from South African assets are likely to be far lower than the previous five years.
The rolling level of annual real returns has already been declining at a rapid rate due to a combination of lower nominal equity prices and rising inflation.
Periods of low returns create high returns
The world would be a far simpler place if assets only went up in price. We are not surprised by the current lower returns, and while it never feels great living through such a period, we are aware that periods of low returns create high returns, and vice versa.

A dispassionate look at expected real returns

We thought it would be useful to take a look at what real equity returns (excluding dividends) one could expect based purely on a ‘quantitative reversion to mean' approach. In other words, what equity returns could we expect if we assume that ‘earnings and valuations return to their longterm average'? We use a similar approach as a sanity check when assessing the expected returns from our own equity portfolio - we add up the expected returns (typically using a four-year time horizon) of our individual bottom-up stock picks.

Real returns are likely to disappoint

The inevitable nature of the business and investment cycle

Earnings tend to revert to their mean (although the pace of the normalisation has differed over history). This is because when profits are above normal not only are profit retentions high, but new capital tends to be underpriced
and readily available. This enables existing businesses to support expansions, makes marginal projects appear worthwhile, and attracts new (often less robust) competitors to compete away excess profitability.

We can still find equities to build a portfolio that we believe can outperform cash over our investment horizon

We believe that the equities in our clients' portfolios should outperform the market and returns on cash (in rands) on a four-year view. We believe these shares share a common characteristic: a current price that is attractive relative to their individual earnings level in a period where earnings are likely to disappoint on the downside.

Commentary by Duncan Artus, portfolio manager, and Lindy du Plessis, analyst, Allan Gray Limited

Recent Articles

Featured Debt consolidation – Explained

Dealing with debt can be daunting. If you’re struggling to keep track of which store account to pay next and weighing up which credit card is more important to settle first, you may have considered debt consolation. At Justmoney, we’ve decided to get down to the basics and explain what this entails and what impact you can anticipate on your credit score.  

Read more

3 Vehicle financing options compared – which is cheaper?

Buying a car is a considered a milestone, both in life and financially. Unless you’re able to fork out the cash, many opt for financing. But often the excitement to drive it off the showroom floor overshadows the need to check if you’re choosing the most-suited option. To help you make the best-informed decision we compare available vehicle financing structures in South Africa.

Read more

Splitwise: Split the bill not the friendship

Collecting your friends’ debt to you can be draining. You don’t want to ruin your friendship with them, and it can also be extremely awkward. I don’t know how many times I have written, deleted, and rephrased texts, reminding people to pay what is due to me.

Read more

Stokvel-friendly accounts – which one is fair?

The stokvel economy is approximately worth R49 billion in South Africa. This is according to the National Stokvel Association of South Africa (Nasasa). Altogether 24% of these stokvels are in Gauteng, while only 6% are in the Western Cape.

Read more

Sign Up

To our weekly newsletter for advice you can bank on

Deals

Cape Town Fish Market Swartland Special

Price: From R123
When: Until 14 July
Where: Cape Town

Aha Casa do Sol Pay 2 Stay 3 Special

Price: R1,200
When: Until 31 July
Where: Mpumalanga

Open University Free Courses

Price: Free
When: Daily
Where: Online