The continued case for equities

Martin Schmulian heads up the Stellenbosch office of Sanlam Private Wealth.

Martin: There’s a saying in financial markets: “If you panic, panic first.” This certainly seems to be the prevailing sentiment right now on our equity markets. Investors disillusioned with market returns over the past few years are asking whether shares are still a wise choice and some are looking to lower-risk
asset classes to enhance overall returns. Are investor fears justified?

Alwyn: One can’t deny that the markets are a scary place at the moment and the recent numbers certainly seem to justify investor angst. Over the past few years, the traditional risk-reward relationship associated with equities appears to have broken down – local equities haven’t rewarded investors for taking on the relatively higher risk of investing in this asset class. 

Since May 2015, the South African equity market has moved largely sideways – the total return for the market over the period was an unexciting 1.9% per year (dividends reinvested). Most economists continue to point the finger at the usual suspects behind the lacklustre performance: the low-growth trap we seem unable to escape, exacerbated by poor macro-economic policymaking and execution.

While there are clearly legitimate reasons for the equity market’s disappointing returns, it should be remembered that when investors start to question a particular asset class, emotion – especially fear – is never far from the surface. In the face of short-term setbacks and uncertainty, people tend to lose faith in tried-and-tested long-term investment principles, thinking that ‘this time is different’. Investors start overreacting and making decisions based on recent short-term experience at precisely the wrong time, which more often than not costs them dearly in the long run.

Martin: Well, we know it’s human nature to get excited about short-term gains and losses on the stock market and it’s sometimes hard not to get caught up in the media hype impacting the market. As professional asset managers, we need to focus on the facts, however, and the most important is this: over the long term – and by this we mean a full investment cycle – equities have significantly outperformed every other asset class. Taking a longer-term view, nothing trumps shares when it comes to inflation-beating returns.

Alwyn: Indeed, Martin, the facts speak for themselves: since 1960, there has never been a rolling five- or 10-year period in which equities delivered a negative return. In fact, the median return over five years since 1960 was 17%. The following example clearly illustrates that to grow wealth at a rate that beats inflation, investing in equities is crucial: if you had invested R10 000 in the money market in 1960, you’d have got a return of R2.8 million at the end of 2018, whereas the equity market (dividends reinvested) would have delivered R74.8 million, a before-inflation return of 16.3% per year! 

Martin: The long-term picture is clear. The risk-reward relationship in our equity markets does sometimes disappoint over the short term, but the price of impatience during such times may well be losing out on the significant opportunities that will inevitably arise as the financial cycle takes its course and the markets start to recover.

“The bottom line is that to achieve long-term investment goals, investors need to be patient enough to stay the course over time.”

Alwyn: Yes, since 1960 there’ve been quite a few such disappointments, most notably the 1998–2003 period, when investors became highly disillusioned with the five-year performance of stock markets. Similar to our current scenario, there were ‘good’ reasons then why the equity market underwhelmed for a sustained period: the emerging markets crisis in 1998, followed by the collapse in global equity prices after the dot-com bubble and a slump in our currency. 

Several ‘experts’ argued at the time that the conventional risk-reward relationship could no longer be trusted and many investors lost patience with equities. But those who did, paid dearly for their impetuousness. They lost out on what was subsequently the longest and strongest bull market in South African equities since the 1960s.

Martin: Of course, we can never say for sure that our current equity market slumber is not different this time. But as asset managers, we know our safest course is to look at and learn from the patterns that have emerged over the years and to remove emotion from our decision-making.

Alwyn: Yes, in our view, the crucial question isn’t whether investors should remain invested in equities or not; the focus should rather be on what will happen if they don’t. The fact is that missing out on the high-return months of our equity market over time can make an enormous difference to the long-term performance of an investor’s overall portfolio. 

We recently conducted a study in which we isolated the top 40 months in terms of
investment performance since 1960 (6% of the 708-month period under review). We found that missing out on the performance generated in this small but crucial proportion of the time would have resulted in an investor’s annualised return over the period dropping from 16% to 8% (R10 000 invested in 1960 would have returned only R827 000 at the end of 2018, compared to R74.8 million had an investor remained in the market for the 40 months in question). 

Martin: The bottom line is that to achieve long-term investment goals, investors need to be patient enough to stay the course over time. The evidence suggests investors seeking an inflation-beating investment outcome can’t allow themselves to miss out on the long-term rewards promised by equities as an asset class. And the only way to do this is by allocating a certain portion of assets, appropriate to each investor’s risk profile, to equity markets.

Alwyn: Yes, we’re not for a moment suggesting investors shouldn’t manage the asset allocation of their portfolios actively. In fact, we believe that doing so successfully will add material value to investor portfolios – it’s important to allocate assets such as equities and cash tactically at times. However, investors thinking about jumping the equity market ship just because the seas are a little rough are ignoring the lessons of history at their own peril. The traditional relationship between risk and returns will continue to hold in the long run. It’s not for nothing that the most expensive words in investing are ‘this time it’s different’.


Important information  This article is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed here are based on information received from a variety of sources that we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam Private Wealth. Any expressions of opinion are subject to change without notice. Sanlam Private Wealth (Pty) Ltd, registration number 2000/023234/07, is a member of the Johannesburg Stock Exchange, a licensed  Financial Services Provider (FSP37473) and a Registered Credit Provider (NCRCP1867).