Melville du Plessis, Portfolio Manager at Sanlam Investments
Ask an audience of investors whether they have seen Halley’s Comet, and you will only see a smattering of hands raised. The reason: the comet travels in a fixed, multi-year orbit and is only visible from Earth every 75 years. Halley’s Comet is a good analogy for the more recent experience of a new (sic) investment paradigm: volatility and uncertainty are part of financial market DNA, yet many investment professionals seem to feel that they are experiencing conditions vastly different to what they have grown used to.
Those making investment decisions these days feel as if they are doing so in a new paradigm, especially for anyone who has grown accustomed to the world of zero (and negative) interest rates, which seemed to have become the norm in many places around the world during recent years. But if you consider the history of financial markets, you quickly realise that the more things change, the more they stay the same . . .
The last six to 18 months have felt like one of the ‘wilder’ periods in the global financial markets. We have witnessed inflation spiralling out of control for the first time in decades, central banks rapidly raising interest rates, and asset class returns flip-flopping from one extreme to the other. Frame this in the context of a global pandemic, the more mainstream acceptance of artificial intelligence technologies, and the heightened concerns about economic prospects, employment and financial conditions – and it would appear we have been allotted an unreasonably tough set of circumstances to deal with. However, if you were managing funds in the late 1970s, 1980s or early 2000s, your experience may have been quite similar in more ways than may seem overtly apparent.
The rate of change in inflation and interest rates is perhaps the main contributor to this feeling of a new investment paradigm. After all, post the 2007-2008 Global Financial Crisis (GFC), we entered an unnatural period of ‘lower-for-longer’ interest rates, with near-zero returns on the table for the better part of the last 15 years. Things became so extreme that around US$18 trillion debt was trading in negative-yielding territory at the peak! At the time, multi-asset fund managers had no choice but to adopt a certain acronym for their asset allocation strategies – TINA: There Is (was) No Alternative.
The interest rate (or discount rate) you apply to investment decision making is, in many ways, one of the most important variables to consider. As such, the global interest rate movements significantly impact all global asset allocation return prospects and investment decision making by extension. Returning to our earlier observation about investors’ experience and the new investment paradigm, many investors and analysts working in financial markets today would have no experience working in a non-zero interest rate environment, which essentially kicked off in 2008 in the aftermath of the global financial crisis.
Today’s market conditions represent one of the most seismic shifts in the global economy and financial markets in the last 15 years or so. This shift is particularly noteworthy for investment decision makers and financial market participants who generally have had limited exposure to an environment of non-zero rates. It might look like a new investment paradigm because the weight of the collective human market knowledge interprets it to be so. In reality, financial markets have been at these type of junctures before, in fact, for most of financial market history.
From a portfolio construction perspective, we find ourselves at a very interesting and exciting juncture. Fixed income markets are offering some of the best yields and potential return prospects pretty much since the turn of the century, allowing our funds to benefit and, potentially, produce quite exceptional performance going forward (both outright as well as on a risk-adjusted basis). Case in point, the Sanlam Investment Management Enhanced Yield Fund is delivering ever higher returns and is also well ahead of its benchmark on the back of higher yields from the healthy mix of local floating as well as fixed rate assets. The Sanlam Investment Management SA Active Income Fund is performing similarly well, and we have been able to position ourselves in very high-quality investments, which are still able to deliver superior returns with a very good trade-off between returns on offer, as compared to the measured risks. And the positive outcomes continue to accrue for the Sanlam Investment Management Flexible Income Fund, where the advantages of an expanded investable universe are a noteworthy benefit to clients.
Fixed income markets have been exhibiting extreme levels of volatility as analysts wrestle with the incredible pace of central bank interventions, especially in developed markets. As we pen this article, the US federal funds rate was at the highest level so far this century, and with a flurry of debate raging over the future path of policy decisions it is fair to say that further hikes are not entirely off the table. We have, of course, also witnessed longer-dated bond yields trace notably higher. In fact, they’re at their highest level since the GFC on the back of a very specific set of identifiable and quantifiable shifting market dynamics. The implication being that the genuine, real return from cash and fixed interest instruments now offers a more welcome tailwind when constructing fixed income portfolios. It does, however, introduce a layer of complexity to asset allocation decisions. Not least of which is the question around what the relative weighting should be, which is assigned to the outlook for the so-called fundamentals of an investment decision as compared to changes in the macro environment, in particular interest rates. All of this needs to be considered in the face of the still ensuing debate regarding the potential for softer economic conditions ahead, or even the looming threat of recessions in many economies around the globe.
This investment paradigm, although not a recent experience, is not a new phenomenon. After all, the foundational tenets of fund management and investing remain unaltered, as do the fundamental drivers of investment returns and associated portfolio construction considerations.