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HERMAN VAN PAPENDORP
HEAD OF MACRO RESEARCH &
Mr Van Papendorp has worked in financial markets for the last 26 years as both an economist and investment strategist. He was chief economist at BoE Securities (previously known as Senekal, Mouton and Kitshoff) in the late 1990s and then spent time as investment strategist at ING Barings, Citigroup and Renaissance Capital (previously known as BJM Securities). He was South Africa’s Economist of the Year in 1998 and has been rated in the top five of the Financial Mail Investment Analyst ratings during most of his career, holding the number one or number two investment strategist position a number of times. Herman joined Momentum Asset Management in May 2013 and currently heads up investment research and asset allocation at Momentum Investments. Herman holds B Com (Actuarial Science), B Com (Hons) (Economics) and M Com (Econometrics) (Cum Laude) degrees from Stellenbosch University.
How outcome-based investing can trump global economic challenges
By Herman van Papendorp, Head of Investment Research and Asset Allocation and Eugene Botha, Deputy Chief Investment Officer, at Momentum Investments
The mindset of investing changes dramatically when an investor decides to invest to deliver on a specific goal or objective, rather than hunting for the next best opportunity to make money. This leads to a considered approach of outcome-based investing. It has a systematic focus on investors’ needs and requirements to grow their wealth and follow a well-thought-out approach to achieve these at some point in the future. It’s not about trying to make a quick gain and definitely not an outright gamble or speculative trade.
Prudent wealth creation or financial goals are typically longer-term orientated and therefore the investor should have a long-term mindset when making investment decisions. However, a short-term approach to investing is not always wrong. More often than not, certain financial goals in life are of a shorter-term nature. Investors need to make investment decisions accordingly to deliver on the goal with the highest certainty over the given investment horizon. The secret is in how to construct the portfolio to deliver on the required objective. Time is usually an investor’s friend. The longer the investment horizon, the more certainty investors have of achieving the required outcome.
It is, however, important to understand the market environment and dynamics at play, as this often drives not only the behavioural aspects of investors over the short term, but also influences the outcomes over the longer term.
This also shows the importance of understanding why the global growth backdrop has seen a remarkable about-turn for the worse in recent years. Having experienced a synchronised recovery as recently as 2017, with most major regions experiencing accelerating growth momentum at the time, the world growth trajectory is now one of synchronised slowdown. Momentum is being lost over a large number of regions (see graph 1).
GRAPH 1: From global synchronised recovery to synchronised slowdown
The two main drivers for this deterioration in the world’s economic growth fortunes have been less favourable monetary policies and trade frictions. Firstly, until 2016, developed world central banks kept policy rates around historical lows, while pushing additional liquidity into their economies through the policy of quantitative easing. Since then, policy tightening has become more evident, led by the US central bank (the Fed) pushing up interest rates at a more aggressive pace, while culling their liquidity injections into the global financial system. The negative lagged effect on growth of this less conducive monetary policy has become increasingly evident since 2018. Secondly, the rising threat of trade wars between the US and its traditional trade partners has become an additional constraint to global growth since 2018 (see graph 2). As long as the US continues to feel aggrieved that its historical role as global geopolitical stabiliser has benefited the rest of the world disproportionally more than itself, trade tensions will likely remain. In this regard, economic growth in Europe and emerging markets that have a high export dependency are most at risk from the ‘new normal’ in trade relations with the US.
GRAPH 2: Growth in global trade volumes
Source: CPB World Trade Monitor
Unfortunately, the reality is that global policymakers have a limited tool set to counter the synchronised slowdown. With global interest rates still not far off their 5 000-year lows (see graph 3), room for rate cuts outside the US is very limited, leaving more quantitative easing as the only viable option. However, with sovereign bond buying in Europe already close to current regulatory limits, the European Central Bank will have to start contemplating buying other asset classes like corporate loans or equities as part of its quantitative easing mix. There is also little room for additional fiscal stimulus from constrained budget positions outside of Europe (notably Germany) and selected emerging markets (mainly Russia and South Korea) (see graph 4).
GRAPH 3: Global interest rates close to historical lows
Source: Bank of America Merrill Lynch
GRAPH4: Government budget balance (percentage of GDP for 2018)
So what are the broad investment implications from this global reality of synchronised growth slowdown amid limited policy options?
Many asset classes face low returns in coming years in an envisaged environment of low growth and low interest rates.
Greater volatility and dispersion across asset classes should be expected in a more unstable and unpredictable world.
The low margin of safety asset classes could be particularly exposed (for example US equities and global bonds).
Momentum Invetments’ outcome-based investing philosophy and portfolio construction approach should prove to be a superior strategy during the anticipated challenging market environment. It will provide investors with an enhanced probability of attaining their ultimate investment goals and manage the client experience en route to the destination. By making the journey less stressful for the investor, particularly during periods when asset prices fall or volatility spikes, irrational investor behaviour (selling at the bottom when market sentiment is despondent or buying at the top when market sentiment is exuberant) can be limited by keeping investor sentiment on a more even keel over the investment horizon.
Here are some of the key considerations to offset behavioural biases:
Avoiding bad investment behaviour that could torpedo good investment outcomes.
Typical consumer behaviour is to buy when goods are on sale rather than when they are expensive. It is therefore surprising that typical investor behaviour turns out to be the exact opposite – to invest when prices are rising rather than when they are falling. A recent global study shows that the average US investor underperformed asset classes and portfolios in the last two decades due to looking in the rear-view mirror too often – buying previous winners and selling previous losers (see graph 5).
GRAPH 5: Twenty-year annualised returns by asset class (1999 to 2018) in the US
Source: JP Morgan
TABLE 1: Behavioural biases that caused this poor investment behaviour
“Buying on the cannons and selling on the trumpets.”
We continually evaluate recent underperforming asset classes to potentially enhance future returns. Although investing in unpopular asset classes is a lonely strategy, it can be very lucrative. This is very applicable to South African equities and South African listed property, which have both experienced very lean times in recent years. These opportunities are often evaluated from a strategic perspective and a shorter-term tactical perspective to align to the overall outcome of the solution.
This is done by increasing portfolio quality. One example is by investing in equities with high-quality characteristics. Quality can also be defined as asset classes or strategies that will offer risk diversification and increased downside protection when turbulent times are expected or when valuations of specific asset classes have become stretched.
Exploring alternative and real assets to enhance returns.
Alternative risk premia are important in client solutions, given the investment attributes of risk management and yield enhancement they can bring to traditional asset classes and strategies within a broader portfolio. We believe there is a requirement for alternative premia in a client solution over the longer term, given the benefits they add, especially in the low-yield environment evident in the market. These asset classes typically include infrastructure, physical property, and natural resources such as agriculture, energy resources and physical commodities. In the case of private equity specifically, the global trend is that private markets now provide wider exposure to new growth areas (shares) than public markets and should hence be explored for additional alpha-generating opportunities.
Often clients get tripped by the costs of alternative asset classes and, therefore, adding value should always be measured on the value added after costs. We also believe certain alternative premia can be replicated in a passive or systematic way to deliver on alternative profiles in a more cost-effective way.
During a challenging and unpredictable market and investment environment and to help manage the behavioural biases humans so often struggle with, the advantages of our outcome-based investing philosophy should clearly come to the fore. A major benefit of the outcome-based investing approach is our ability to use the full universe of portfolio management alternatives to take advantage of the benefits of diversifying across multi-asset class capabilities (taking advantage of traditional and alternative premias), multi-strategies (exploring the return drivers within each asset class) and multi-mandates (choosing the most suitable investment manager for each strategy).
It also combines the best of breed characteristics of a single investment manager approach (using existing superior in-house skills), a multi-manager strategy, passive investing (little cost leakage when returns are low) and active management (enhanced alpha-generating ability when asset class correlations are low and dispersions high) – all very important and a requirement to navigate the low global yield environment we are facing.