By Wade Witbooi, Portfolio Manager at Glacier Invest
The investment landscape has been evolving over the past few years, changing the way financial advisers, institutions and individuals think about investing. Added to this, the global pandemic brought with it the fiercest bear market the modern world has ever seen, with unparalleled fiscal and monetary stimulus and extreme market volatility. Given that uncertainty is the main driver of market instability, we believe it is extremely important to understand how the current developing environment is impacting both investors and advisers.
In this article we’ll touch on the recently observed trends and how we have adapted our thinking around the way we manage money to evolve along with emerging trends. Finally, we look at advisers and investors’ main concerns, and how we have created practical solutions to solve for them.
The rise of the retail investor
While it was thought that the initial retail trend was speculative, many more investors are entering financial markets. The influence of social media, combined with the growing accessibility of digital trading apps, has transformed the investment landscape for the retail investor. For decades, retail investors had a very limited ability to invest in stock markets. However, through apps such as Robinhood, investors have easier access and now have the opportunity to invest with smaller amounts than before. Locally, we have seen a similar trend growth in users on the Easy Equities investing platform. As access to financial markets and investments continues to be democratised, it is likely that this market segment will continue to grow.
Figure 1: Monthly net purchases of US equities by individual investors
In the graph above, monthly new purchases of equities by US investors experienced the biggest ever observed uptick, fuelled by demand from new investors wanting to get involved in stocks, which has been in an upward trend since April 2020.
The evolution of cryptocurrencies & decentralised finance (DeFi)
Since the initial proposal and the popularisation of bitcoin, hundreds of cryptocurrencies have been launched. Some exploited gullible investors seeking huge gains, promising to send their money “to the moon”, while others had reasonable use cases. Furthermore, increased interest in the use case of the Blockchain led to the birth of NFTs (non-fungible tokens). Briefly described, NFTs are digital assets on a blockchain, with unique codes that cannot be duplicated. The demand for NFTs spiked in 2021, with NFT platform Opensea reporting monthly volumes of $3 billion, and the entire NFT market now estimated at around $40 billion.
Another phrase increasingly being used is Web3, which is the evolution of the current internet, referred to as Web2. Web3 claims everything will be decentralised, open and give users greater utility from the internet. Users could have greater control over their data and share in the monetary value of the internet instead of websites profiting from their data and daily online activity.
More recently we’ve seen large financial and investment companies starting to explore DeFi, creating in-house teams, and launching investment products to meet demand. While the use case is still not entirely clear at this stage, there has definitely been an increase in activity from traditional investment/asset management companies.
The age of exchange traded funds (ETFs) is looming
We’ve seen a big shift in demand for passive investments both globally and locally, driven by enhancements in quantitative finance and a strong focus on cost optimisation in the investing value chain.
Figure 2: Global assets under management (in trillions of dollars)
Source: MorningStar Direct
The market dynamics have, however, shifted. Previously ETFs were passive, and market-cap weighted, whereas now ETFs are being dominated by active and thematic ETFs, providing investors with the option to invest in a wide range of thematic ETFs to gain access to a theme or trend which speaks to their personal investment objectives. Such themes include ESG and artificial intelligence (AI). Many established mutual funds are also converting to an ETF to take advantage of the capital gains tax benefits of the structure within the US tax regime. (In South Africa the tax treatment of unit trusts and ETFs are aligned.)
This led to the next evolution of index investing: custom indexing. Investors are able to specify what they want to invest in, and an ETF product can be made to suit their specific needs at low cost.
Environmental, social, governance (ESG) factors become mainstream
Over the last few years there has been more focus on the continued consequences of climate change and various other social and environmental issues. This has resulted in both experienced and new investors increasingly embracing funds with more sustainable stocks. Investors are favouring companies that act to address the climate crisis and other environmental and social issues, like resource conservation, biodiversity, and human rights.
As the interest in ESG steadily increases, we are seeing the world moving towards investment and the development of more sustainable sources of energy, transitioning away from fossil fuels.
Following the recent COP 26 conference in Scotland, major nations made commitments to use more sustainable sources of energy to reduce carbon emissions, further supporting the increased interest in ESG. This is part of their commitment to the path of net-zero carbon emissions by 2050 as can be seen below.
Figure 3: Greenhouse gas emissions targets and Global energy mix
Source: JP Morgan Guide to the Market, December 2021
We also see investor demand for more sustainable investments rising. One of the reasons can be the fact that many ESG funds have shown resilience during the pandemic. Relative to traditional funds, funds which had an ESG tilt were not as impacted during that initial market downturn when the pandemic first hit. The market also saw a sharp increase in US sustainability fund flows, with investors allocating broadly in both actively and passively managed strategies to get access to sustainability-focused investments. This can be seen below, as monthly net flows posted an all-time high during 2021.
Figure 4: US Sustainable Fund Flows
Source: Morningstar Sustainability Matters, September 2021
Global and local trends in alternatives
With global equity markets trading at elevated multiples and real yields on global bonds deeply negative, investors are looking towards private markets for additional sources of return to match their long-term liabilities. Today we can see growing portfolio diversification as investors move from local to global portfolios, allocating away from traditional investments and towards alternative investments. As illustrated below, infrastructure is currently one of the fastest growing subsectors in private equity in recent times.
Figure 5 : Global private capital fundraising
Source: JP Morgan Guide to Alternatives, November 2021
The very simple reason behind the choice of adding alternatives to a portfolio, is that the careful addition and use of alternative investments can mitigate downside risk and enhance upside return potential over the long term.
Locally, the growth in the alternatives space has also ticked up, as investors seek alternate sources of risk and return. Hedge fund assets under management (AUM) in South Africa increased to R61.5 billion in 2020 from R1.4 billion in 2002. Accessibility to hedge funds in SA has improved significantly, with new asset managers being launched, greater transparency, new regulations, and retail investor hedge fund structures. This allows greater access for individual investors with lower barriers to entry, such as more affordable minimum investment amounts and daily liquidity.
Figure 6: Hedge Funds industry assets over time
Source: Novare Hedge Fund survey, 2020
The South African Venture Capital Association reported the private equity industry in SA reached a record high of R205 billion, with infrastructure investments a third of the total market AUM currently.
Changing landscape and the South African Investor
Given the changing market landscape and new ways of thinking about investing, it is also imperative to understand how our clients and their clients are being challenged and how we can evolve as a business to help them meet their financial needs. We therefore commissioned an external research consultant to survey the local financial adviser landscape to gauge local trends and demands of the SA financial adviser.
An interesting observation was that many of the concerns that are currently on investors’ minds can be linked back to uncertainty regarding the stability of the political environment in South Africa and how this impacts markets and the economy. It is also important that these concerns gave rise to interest in different asset classes and either directly or indirectly can be linked back to the investment ideas that are currently trending.
Below we unpack some of the more pertinent issues that clients are focusing on:
Political concerns and implications of instability. A key concern noted was political risk, followed by poor economic growth prospects. Financial advisers also mentioned the burden of regulation becoming increasingly challenging and their client base shrinking due to immigration. On average, fears around the impact of COVID-19 on their practice appear to be less of a concern than originally expected.
Local uncertainty results in increased interest in offshore investing. The interest in offshore investing is growing significantly given the increased concerns arounds SA’s political and economic situation.
Allocations offshore are steadily rising, with advisers ideally looking to allocate more than 50% of client capital beyond our borders. Recent changes made to Regulation 28 to allow a maximum of 45% of client capital offshore seem to be roughly in line with adviser trends.
The primary drivers for considering offshore investing are diversification to reduce risk and enhance returns; political uncertainty and the fear brought on by the corruption within the South African government; local currency inflation and the view that over time the South African rand will weaken further – going offshore would offer protection for retirement assets.
Increased interest in the alternatives space. The IFAs were surveyed around their interest in alternative investments such as private equity, infrastructure and credit. In response, more than 50% of advisers indicated they would be interested in their inclusion to enhance returns and manage volatility.
Passive allocations have continued to grow, and advisers predict further, rapid growth.
Figure 7: IFA commentary on Passives
Source: External Research Consultant Survey, 2021
As illustrated, there has been an increasing trend in passive investments in SA. The passive space was previously dominated by equity strategies but has grown in other asset classes, as well as multi asset funds. SA financial advisers are also increasing the use of passive investments to better manage their strategic asset allocation and maintain costs.
Solutions architecture – understanding our clients and deliberate portfolio construction
One of the major takeaways from the external research consultant survey we commissioned was the rise in centralised investment processes via discretionary fund managers (DFMs) such as Glacier Invest. Advisers are increasingly relying on investment experts to guide their decision-making and form investment committees for continuity in their practices.
One of the pioneers of quantitative finance and portfolio construction, Harry Markowitz, once said: “A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies.”
This is also how we shape our thinking around building portfolios in a fast-changing world.
Sanlam Investments Multi-Managers, the investment arm of Glacier Invest, designs specific portfolios for the client journey, differentiating between pre- and post-retirement and how we manage and define risk. We believe a deliberate focus on providing living annuity clients with stable and diversified portfolios to manage volatility and sequence risk could lead to better and more predictable outcomes. We believe one cannot solve for the decumulation phase using the same techniques as you would use in the wealth accumulation phase.
Specific portfolios for post-retirement clients: During the last decade a plethora of research was done on retirees – the conclusion of most of it is that across the world, including South Africa, retirement is a constant battle for the average person. The solutions and products in the market were generally either a living annuity or guaranteed annuity upon retirement. Neither of these options fully addressed the two major risks that retirees face. Upon retirement, the greatest risks are: that you may outlive your retirement capital (longevity risk), and the negative impact of sequence of return risk caused by adverse market conditions on your portfolio once you are retired.
At Glacier Invest, we believe that new thinking is required to solve the investment-linked living annuity problem for retirees. Therefore in 2020, we launched our living annuity portfolios which specifically combine superior active managers, strategic and tactical use of passive investments, alternative investments in hedge funds, structured products, and private markets, and used specific portfolio construction techniques to optimise allocations. We believe it is necessary to use the full range of appropriate portfolio construction tools available to reduce investors’ longevity and sequence risk, and provide the golden retirement solution, a sufficient and stable retirement income for life.
Recently, we’ve also been able to make these portfolios available for discretionary investors via our endowment product.
Offshore options to alleviate fears and increase diversification: In order to meet the interest and rising demand for offshore investing we have also launched our global solutions across risk profiles in dollars/euros/pounds. These solutions, like all of our offerings, are built on the same investment methodology and principles. By combining our manager research skills, market research process and our unique approach to portfolio construction, we have created specialist risk-profiled global portfolios, based on a building-block approach. These portfolios, which are diversified across asset classes using a robustly tested asset allocation framework and various investment styles and factors, are created to deliver superior long-term investment returns above our customised benchmark – the Strategic Asset Allocation (SAA) – regardless of market cycles.
ESG focus: As guardians of our clients’ wealth, our purpose has progressed well beyond just wealth creation. Sustainability has always been a factor we consider. But now more than ever, the focus on ESG is mission critical for the future in general. We have thus incorporated an ESG process into our manager research process and we are currently developing ESG reporting for all portfolios.
Passive investing – nothing new to the portfolio construction process: We continue to use passive investments both strategically and tactically within portfolios, and will continue to engage with our clients to better build solutions for their needs.