Generating alpha in a polycrisis world

Both local and global markets face multiple risks that affect the ability of local long-only and hedge fund managers to deliver benchmark-beating, risk-adjusted returns. The list of factors includes but is not limited to: macroeconomic shifts in policy aimed at managing inflation, geopolitical tensions, the “China” effect, supply chain disruptions, and consumer balance sheet deterioration post the 2020 pandemic.

With this confluence of factors affecting markets in 2024, the investment community understandably believes we are operating in a “polycrisis” world. Where, then, should you focus your attention? This was one of the themes of a panel discussion I hosted at the 2024 HedgeNews Africa Symposium.

The increased foreign allowance, from 30% to 45% of assets under management, has expanded the horizons for managers. While this was a well-intentioned regulator move, it has unfortunately contributed to a significant reduction in trade volumes on local equity markets and reduced liquidity in local fixed-income markets.

Adding to the problem, we are seeing that in this critical election year, market participants are maintaining elevated cash weightings, fearing that mispricing risk, in this multifaceted, polycrisis environment, could result in permanent damage to portfolio returns and carefully accumulated track records.

Finding the information asymmetry edge

Extraction of value via information asymmetry (access to insights not readily available to all) is a difficult task when it comes to listed instruments since most players enjoy an oversupply of duplicated insights.

There are more research pieces in e-mail inboxes than there is time to absorb and understand, not to mention the series of calls by analysts and sales traders. How do we extract alpha in a market where we have the same information as everybody else?

One area where information asymmetry can work is to the benefit of funds focusing on private asset classes and alternative asset classes, such as commodities, private debt and equity. However, this relies on a painstaking extraction of information in a process prone to various biases. (Just because you know something everyone else doesn’t know, doesn’t mean it’s the opportunity of the year!)

Protecting portfolios in an election year

For locally-focused funds, the privilege of making decisions with local information alone can leave them exposed, given the spillover effects of global events. This makes for a difficult task of weighing the importance of information in the investment process, especially in an election year.

Protecting portfolios is agenda item number one in many morning meetings. The “make or break” status of this election result has necessitated the purchase of insurance outside of the traditional single-asset method.

Out-of-the-money put options on USD/ZAR, cheap shorts on globally exposed credits or any way to bet against the fortunes of the local economy, have taken the limelight from the periodic coupon reinvestment, NCD allocation, corporate bond auction participation and the occasional, intriguing bank-structured trades.

This sentiment also weighs on the fortunes of SOE issuers looking to raise cash leading up to the elections in May, since already underweight positioning will be exacerbated by maturities taking place close to the elections. The likes of Transnet, IDC, DBSA and similar institutions have their work cut out from a funding perspective and the cost of liquidity will take a back seat to filling the quantum required.

Corporates’ positioning and liquidity challenges

While our focus is on the investment community in this piece, we cannot ignore the corporate community and its positioning leading up to May. It’s no secret that many of the high-quality credits sit on historically high levels of cash as economic certainty is required before embarking on long-term capital budgeting initiatives.

This has limited corporate assets to refinances and bond issuances to a quantum designed simply to maintain visibility in the market. This technical scarcity continues to distort the true price of liquidity.

Further, investors must compete with banks for whom asset growth is the main imperative. So where does the buck stop? When do providers of liquidity halt the chase to the bottom? The banks themselves are so cash flush that barring mandatory SARB placements, the drag on net interest margin will only abate post-election when local investment picks up again.

Conclusion – themes to watch in 2024

Given all the above, what are the themes and trends likely to dominate in 2024?

1. Emerging markets are undervalued relative to developed markets purely because of a shortage of available data. Investment houses should be careful not to be biased in favour of opportunities where there is more available data. The alpha opportunities lie where no one else is looking, such as private debt, private equity and hedge fund strategies.
2. Enhancement of technology and AI will become key differentiators in extracting alpha from readily available information and in areas where there is participant saturation.
3. The ability to diversify offshore is a double-edged sword but a rand hedge is non-negotiable in 2024.