The 12 months of 2022 may have proved disappointing for many South African investors, but there were ample opportunities in local financial markets to take advantage of cheap asset valuations that added value to portfolios. Risk management through wide diversification and careful asset selection were also key to adding value and protecting portfolio downside. We’re sure that all three of these elements will hold true in 2023 as well.
Looking at the opportunities ahead, in our view, SA bonds continue to offer investors strong prospective returns compared to history and relative to other markets, even after having outperformed global bond markets in 2022. For example, our 10-year government bonds started 2023 with a yield of over 10%, and our analysis points to a prospective real return of 5.7% p.a. from these assets over the next five years or so, significantly above their 3.0% p.a. historical real return. And compare this to the 0.9% p.a. real return we would expect from global bonds over the same period. SA real yields also compensate investors for the elevated inflation and interest rate risk we are experiencing.
SA equities are also presenting good buying opportunities as the FTSE/JSE Capped SWIX Index ended 2022 on a 12-month forward price/earnings ratio of around 9.0X, below its historic average. Our latest analysis shows a prospective real return of around 9.5% p.a. over the next five years from these assets compared to a long-term average of 7.0% p.a. Within equities, some caution is required: we prefer companies with strong balance sheets, those that can pass on price increases to customers to protect their margins, and those that can benefit from higher interest rates, like banks.
We believe SA banks like Investec, Absa and Standard Bank have been, and continue to be, trading on undemanding valuations, especially given that they are well-provisioned and their earnings and dividend growth are currently exceptionally strong. As such, we are overweight the banking sector in many of our client portfolios.
Other equities that we consider attractive are Naspers and Prosus. These shares were battered last year by the travails of Tencent, their underlying holding, following the Chinese government’s imposition of tighter regulations on the gaming industry and the broader global sell-off in technology stocks. However, December and January saw Chinese elections, the lifting of the exceptionally strict Covid lockdown regulations and a restart in licensing, as the government aims to revive very slow economic growth. These all helped improve Tencent’s growth outlook. In turn, the Naspers and Prosus share buyback programmes also helped narrow their discount to Tencent, leading to significant outperformance in December. We expect this improvement to continue as the shares still have much value to recoup.
Meanwhile, we believe other South African assets are less attractive than bonds and equities. Our multi-asset funds are neutral or underweight inflation-linked bonds (ILBs) and listed property. ILBs offer less attractive prospective returns than nominal bonds, despite the inflation protection they provide, while property stocks are facing greater headwinds to growth. Our listed property holdings include companies with lower exposure to the hard-hit office sector, and those focused on logistics and storage.
Finally, offshore investments are also vital to include in any 2023 portfolio, thanks to the important diversification benefits they offer; but, as in South Africa, investors need to be selective in their equity choices. US Treasuries are the most effective assets in countering local equity risk, with 30-year USTs, in particular, offering attractive yields for the first time in many years.