Macro Perspectives 24 | Risk: A double-edged sword shaping opportunities and threats

South Africa now illustrates the double-sided nature of risk. Sentiment is dire, but assets are cheap, and there's potential for recovery with Chinese growth, private sector electricity delivery, and foreign investor interest. Like China, investing in new economy sectors will be crucial for our development.

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Chapters

• 0:14 The challenge of defining risk and how South Africa is a great example of double-sided risk
• 1:28 How China also offers a double-sided risk profile
• 2:26 Peter explains his personal preferred definition of risk and managing a solution

Transcript

Peter Brooke  00:00

Good day. I'm Peter Brooke, a Portfolio Manager at the Old Mutual Investment Group. This is Macro Perspective 24 of 2023, and I want to talk about risk. We've just done one of our big risk meetings, looking at the different risks to our portfolios, and to the world. 

Peter Brooke  00:14

Now, one of the challenges when discussing this, is risk is a difficult subject, as everyone has a different definition. And many people only think of risk to the downside, whereas risk is double-sided. It can be both positive and negative. I think South Africa is a great example of this at the moment. As we freeze in Cape Town in the winter of our discontent, sentiment towards South Africa is dire. But the market knows this, and our assets are very cheap as a result. In our philosophy, this is a classic value trap: bad theme and cheap price. 

Where risk comes in, is where do we go next. If we are a failed state, as some commentators suggest, then our assets are not really cheap. However, there's also a path where Chinese growth recover is helping our commodities, the private sector delivers electricity, and the capacity comes back from Medupi. This allows the economy to recover from very depressed levels, we get the elections out the way, allowing foreign investors back in. And then, when prices are low and, and positioning is light, you've got to remember that not as bad, is good enough. 

Peter Brooke  01:28

China also offers a double-sided risk profile. There is the downside of Taiwanese geopolitics, and the upside of increased stimulus. On a longer term basis, we've got the challenge of poor demographics and higher leverage, resulting in Japanese-style deflation. Or, you have the upside of a shift from savings and production to a high services based economy like the United States. 

Peter Brooke  01:54

Interestingly, my colleague, Thomo Molatjane, has just come back from a three week tour of China, and is very impressed by the development and leadership in new economy sectors like AI, green economy, and electric vehicles. This is an area that South African radically needs to improve, particularly with regards to our education system. There's a great article in the Sunday Times, quoting our ex-Statistician General, Pali Lehohla, where you can't reap a demographic dividend, if you don't invest. 

Peter Brooke  02:26

Personally, my preferred definition of risk is not delivering to client perspectives. Now, once again, this can be tricky when managing a solution. Are you aiming at real returns, beating peers or absolute returns? And that depends on your timeframe. And the goals effectively change as the environment shifts. At the moment, I'm focusing on absolute return, and recently added to our US bond exposure. Roughly 25% of my allocation is to bonds, which is on the high end, as typically that money would be invested in equities. 

So, for me, the main risk is that the US market keeps running, and I miss an opportunity to deliver higher returns. On the plus side though, I've got more defensiveness. When we think about global equities, the main risk is treading the narrow path of a soft landing. Too hot and we get more rate hikes, too cold and we get a recession. The interesting thing right now, is that the consensus view has actually shifted to a soft landing, which means we're sitting on a precipice between those two with risk on either side. And that's the whole point of this voice note, which is risk is a double-sided sword. 

I hope you enjoyed this perspective. Until next week.