Winners do not always go hand-in-hand

I’m sure that most people are familiar with the saying about something going hand in hand with something else. Let’s use a cycling team in the Tour de France (TdF) as an example. A team consisting of Peter Sagan and Mark Cavendish simply wouldn’t make sense, because their goals for this year’s TdF, and their riding styles go hand in hand. Paring either someone like Geraint Thomas, Tom Dumoulin or Adam Yates with a rider like Sagan would make more sense, as they should perform optimally at different times/stages of the TdF. While both of their aims are to wear at least one of the winners’ colours (either green or yellow), they would probably end up doing so at different stages in the race.

Investments in shares are based on the same hand in hand principle. Although this can be analysed in detail down to individual share level, I would like to discuss the wider application of this principle in relation to different markets and how it can be used when compiling your personal portfolio.

I have lost count of the number of times I have been told how amazingly well US stock markets have performed over the last two years, and how we should actually have invested everything we had in it. And yes, if we had access to 2019’s newspapers in 2014, I would have said “YES!” to such claims. But that’s just because we now know that the US (MSCI USA Index) has grown by 16.2% per year in Rand-terms over the last five years (up to 31 May 2019). And it wasn’t just one of the best performing markets, they also managed to outperform the FTSE/JSE All Share Index by 11% per year, while South Africa with it’s mediocre 5.4% growth per year couldn’t even manage to outperform its own money market rate over the same five-year period. So, I’m well aware of why investors are feeling extremely frustrated at the moment, and why they are tempted to find salvation in offshore markets.

The secret, however, lies in evaluating the TdF in its entirety in order to make an informed decision. Why? Well, if you compare these two markets over a five-year period as opposed to comparing its shifts over a 20-year period, a completely different picture emerges.

The FTSE/JSE All Share Index has grown by 15% per year over the last 20 years (up to 31 May 2019) compared to the USA’s 9.7% (in Rand-terms). Just as with kidney stones, we tend to forget about the pain it has caused in the past. We soon find ourselves leaving the healthy diet we promised ourselves we would follow behind, and before you know it, you wake up one morning to the exact same pain as before. Investors seem to forget that not only did the USA deliver no growth in Rand-terms between May 1999 and May 2009, but that it actually experienced negative growth. I’ll let you dwell on that for a moment. TEN YEARS’ worth of negative growth!

But before investors interpret this week’s message as pro-SA and anti-USA, I just want to go back to the beginning. Remember when I said that you should pair different winners whose characteristics do not go hand in hand?

Well, if we analyse the MSCI South African (SA) Index’s correlation with well-known markets such as the MSCI USA, Britain, Europe, China and even main indices like the MSCI All Country World Index (ACWI) and the regular MSCI All World Index over the last three years, you will find that by only investing in countries like SA and China (MSCI Indices) together, would be a lot like pairing Sagan and Cavendish as a team in the TdF. Both of these markets have fallen on tough times this past year with SA delivering -11.5% growth in US$-terms, while China delivered -18.4%. These to indices also happen to have the highest correlation, which is just a fancy of saying that they go hand in hand.

Graph 1: FTSE/JSE All Share Index vs. MSCI USA Index (in Rand) vs. 50/50 allocations to both (source: Thomson Reuters)

It just so happens that South Africa has the lowest correlation with the USA. If you had invested 50% of your capital in SA and 50% in the USA 20 years ago, South Africa would have been responsible for your portfolio’s performance in the first 10 years while the USA suffered, and the USA would have been responsible for good performance over the last 10 years while SA has been suffering. But I would rather recommend a pairing between SA and the MSCI World Index, as I am a little worried about the USA’s current valuation levels. SA still has a low correlation with the MSCI World Index, and although the index consists of 54% in USA shares, it will provide investors with the reassurance of added diversification. Just take note of the difference between the MSCI World Index and the MSCI All Country World Index: the regular MSCI World Index consists only of developed markets (such as USA, Western Europe, Japan, Canada, etc.), while the MSCI ACWI includes both developed and developing markets.

To conclude, I just want to warn investors to be very careful when selecting last year’s winners. It doesn’t matter whether you’re looking at shares, markets or funds. Rather shift your focus towards winners that don’t go hand in hand.

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice.  This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken based on the information contained in this newsletter. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.


Schalk Louw
As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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