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 Can you afford an ambulance in South Africa?

When a loved one is straddling the line between life and death, you won’t hesitate to call an ambulance. This week, Justmoney found out how much an ambulance ride costs in South Africa, whether you can refuse to get into an ambulance, and who pays the bill if you’re unconscious. 

Read more

Discovery Vitality: The impact it had on my health

It’s nearly 30 degrees outside, but my windows are closed to prevent further wildfire smoke from entering my bedroom. I’m hopping around, squatting and lunging my way into my “cardio zone” so that I can earn 200 points on Discovery Vitality and meet my weekly activity goals.

Read more

Rand runs out of steam in lead-up to budget speech

For all the foreshadowing that was done last week in terms of the two big speeches by the head of states in the United States (US) and South Africa (SA), very little happened as a direct consequence thereof.

Read more

The cover you need at every age and stage

Insurance is often neglected during people’s twenties and inflated during their forties. So, which insurance products should you pursue at which age?

Read more

Sign Up

To our weekly newsletter for advice you can bank on

Deals

President Hotel Easter Special

Price: From R1,500
When: 15 March to 30 April
Where: Cape Town

Kulula-Preskil Island Resort Special

Price: R16,999
When: 11 May -14 September
Where: Mauritius

A Touch Of Madness Tuck In Tuesday Special

Price: R70
When: Tuesdays
Where: Cape Town