The value of being conservative in a highly uncertain market

• By Sade Gertze

BEING described as conservative is often associated with being little old-fashioned. And in today’s fast paced world, old-fashioned is not on trend. There’s seemingly an expectation to be constantly re-inventing oneself and embracing the new at the expense of the old.

However, in a world of ever-changing expectations and volatile markets, there is a sound argument to be made for taking a slightly lower risk approach to your investments – especially in the part of your portfolio that is meant to cushion against the adverse impact of volatility.

Short-term investments like the Standard Bank Namibia Money Market Fund provide stable, long-term returns above those offered by a savings account. This is also a very liquid investment, allowing access to invested capital at short notice.

Returns from low-risk and therefore low-volatility investments, such as the Standard Bank Namibia Money Market Fund, by definition do not show much change on a day-to-day basis. To contain volatility, especially as interest rate hikes are expected to become a reality as early as the first half of 2022, we do not consider it appropriate to take on excessive risk in a portfolio. After a very long period of low interest rates, all indications are that we are at the bottom of the interest rate cycle. Some emerging market central banks have already started hiking rates in response to inflationary pressure. Furthermore, tapering by developed markets would exert greater pressure on emerging markets to hike rates in an effort to remain competitive and attract foreign investment inflows.

When interest rates increase, low-risk positioning serves as a powerful protection from the impact of rising rates on longer-dated fixed instruments, which would lose significant value in such an environment. To manage the inherent interest rate risk, floating rate instruments would be favoured that would benefit from increases in lending rates. This gives the investment upside potential as and when the central bank decides to start hiking interest rates.

Economists and investors disagree about the timing of hikes. The local economy continues to grapple with slow and deteriorating growth, exacerbated by measures put in place over the past two years to curb the spread of Covid-19. While interest rates are as low as they have ever been, their intended impact – stimulating economic growth – is not sufficiently flowing through to growth projects and economic activity. In short, businesses have not been taking advantage of lower interest rates to fund expansion projects.

Arguably, uncertainty about further pandemic-related disruptions outweigh the benefits of a relatively lower cost of funding, and discourages business growth. In this instance, raising interest rates would counter the central bank’s intention of supporting economic recovery, as it would be even more difficult to drive growth in a higher rate environment. Rates may therefore stay low for longer than originally anticipated.

Taking all of this into account, to produce the best money market portfolio outcome would be to maintain a defensive positioning against the impact of rate hikes. This can be achieved through holding floating rate instruments and is the appropriate strategy to manage volatility and protect investors from potential loss.

Since timing is uncertain, a healthy position in higher-yielding fixed rate assets will serve to bolster returns and balance the opportunities in the market – and therefor by being conservative will generate the best outcome for the investor.

Sade Gertze is a Portfolio Manager at STANLIB Namibia.