Quarterly Commentary - Q4 2020

Hope, fear and what lies in between

“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” William Arthur Ward

After the rollercoaster that was 2020, we find ourselves deeply contemplating what may lie in store for 2021. In thinking through some scenarios for the year ahead, the current state of play in markets is a combination of hope and fear.

Hope has finally sprung

The dominant market theme towards the end of 2020 was the strong vaccine-inspired global economic recovery. Combined with low interest rates and increased government spending (primarily in developed markets), this inspired a boom in equities and other risk assets, a fall in the dollar, and a consequent rise in the value of emerging market currencies, including the rand.

One scenario for 2021 sees these positive economic hopes and low interest rates continue to buoy markets. We too would like this upbeat global backdrop and renewed risk appetite to continue – and to feed through to South African assets.

Fear continues to lurk

However, the start of the year has seen some fear creep into market thinking:

  • Continued virus fears: Rising infections and resulting lockdowns are wreaking further havoc, while new strains of the virus continue to emerge.
  • Vaccination rollouts: Economies under pressure (such as our own) are almost certain to lag in vaccinations and to suffer slower growth as the mammoth logistical task of rolling out vaccines becomes evident.
  • The return of inflation in a low-growth environment: The Democrat stronghold in the US speaks to further US fiscal stimulus. Combined with easy monetary policy, rising commodity prices, a constrained supply side and evidence of rising supply chain prices, we could have a return to inflation.
  • Overexuberance: Global markets are at record highs. Eventually, booming valuations will have priced everything in – and the ongoing fear is always going to be that they have run too far.

We avoid swaying with sentiment

With the pendulum swinging between hope and fear, we cannot get caught up in the emotion. Aiming to stay rational, we avoid positioning portfolios for any single outcome. Rather, we consider the probabilities of various outcomes and seek positive risk compensation from individual investments to compensate for being unable to consistently predict these outcomes accurately.

Diversification means more to us than ‘more’

For us, diversification is a trade-off between time horizon, returns and risk, which we define as not delivering the returns our clients need. It is a process that doesn’t necessarily result in our clients making the most money in the short term but optimises the likelihood of meeting our mandates.

The winds of investment opportunity blow in many different directions, at different speeds and at different times. If we had an investment barometer with full foresight, diversification would not be necessary. We would simply hoist the sail that harnesses the most exuberant future winds. Risk would be minimal and returns abundant. However, we have made peace with the fact that we will not be able to find such a barometer and that risk is an inescapable companion on our voyage.

So, do we hoist every single sail and build portfolios that will bob along in just about any waters? Cater for all perceivable weather conditions? Surely, the more sails we have, the lower the risk? Not necessarily. Blindly adding sails (or positions) simply for the sake of perceived risk reduction is not diversification. That’s simply not trying terribly hard and is better described as a dilution of returns. In fact, given our definition, this increases risk.

Diversification is not a numbers game that absolves us from having conviction. It’s there to manage the risks of our conviction. It’s not there to protect us against bad weather for a day or a week. It’s there to ensure we can express our investment philosophy and process to the benefit of our clients in the many years ahead at acceptable levels of risk. It’s there to make sure the ship sails swiftly and safely in unchartered waters and that we reach our destination as planned.

Diversifying is harnessing the highest probability opportunities from a variety of different fundamental drivers. It caters for the odd squall of error or tack of misjudgement. Setting our sails in this way makes it possible to have portfolios with few instruments or fundamental exposures that are still highly diversified.

How do we take this into the waters of 2021?

The Granate SCI Money Market Fund is our boat that sails in only the safest waters. It invests in short-term, rand-denominated instruments of only the highest quality.

For those looking for a sunset cruise along the coast, the Granate SCI Multi Income Fund hoists further sails: fixed and variable interest, inflation linkers, property, corporate credit, a bit of duration and some derivatives. Currently, corporate credit and property are not catching the breeze, but we have large sails out for the fixed, variable and inflation-linked winds blowing.

Finally, our equity-centric funds (the Granate SCI Balanced Fund and Granate SCI Flexible Fund) offer longer voyages across open waters by adding further sails: local and global equities. Spending some time in the same waters as our other ships, they benefit from this knowledge as they consider what lies over the horizon. We currently have sails hoisted to capture potential winds from global opportunities (such as those in semiconductors), a rebound in some of South Africa’s top businesses, and winds that may come from rand-hedged and dual-listed opportunities.

Ultimately, our funds are built to be fit for purpose, and robust enough to withstand unexpected changes in wind. We never hoist only one sail. And we will always be on the boat with you.

“Now—bring me that horizon.” Captain Jack Sparrow

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Portfolio Manager: Vaneshen Naidoo

Portfolio Manager

Vaneshen joined Granate Asset Management in December 2015 and currently manages the Money Market and Cash portfolios in the Fixed Interest Team. He joined Cadiz Asset Management in 2006 as a graduate and during this time analysed the credit and property sectors for the fixed interest and multi asset class teams. Vaneshen holds a BSc. Hons (Engineering) and M.Sc.(Engineering) from The University of Cape Town, and is also a CFA.

CFA ®
M.Sc. (Engineering) (UCT)
BSc. Hons (Engineering) (UCT)