Within the period 1965 to 2015 all domestic asset class returns (except cash) are found to exhibit negative correlations with the contemporaneous inflation rate. Cash has hedging qualities due to Reserve Bank inflation targeting policy action but has a low real yield. Furthermore, Engle-Granger cointegration tests show that none of the asset class prices displays a long-term equilibrium relationship with the CPI. Using local growth assets as “inflation hedges” in a “CPI plus” mandate is more of an attempt to outperform inflation than to actually hedge against it.
In contrast, it was found that “rand-hedge” asset classes could offer inflation protection. Offshore bond returns exhibited a significant positive contemporaneous relationship with inflation over a one- to three-year horizon and was the only asset class to do so. Looking at non-contemporaneous relationships, the prior 12-month rand returns on all foreign asset classes (and the local RESI) were found to be positively correlated with current inflation due to the return enhancement of rand weakening later feeding through into future imported inflation. Thus, rand hedges offer an “up-front” compensation for future inflation and, understood as such, can provide effective inflation protection for locally based investors.
In Markowitz’s (1952) portfolio theory, a reduction in volatility for a given level of expected return is implied as being equivalent to an increase in diversification. The recent development of risk-based portfolio construction methods, which emphasise diversification separately from volatility reduction, challenges this equivalence. Using a point-in-time database of liquid equities listed on the Johannesburg Stock Exchange between 1998 and 2016, a numerical simulation technique is employed to study the behaviour of a range of diversification measures as a portfolio-level attribute and assess and compare their usefulness in estimating out-of-sample portfolio volatility. The empirical performance of maximum diversification portfolios based on each measure is then investigated. It is found that a portfolio’s diversification level is a significant predictor of future portfolio risk beyond that of historic volatility, and that the empirical performance of maximum diversification portfolios, attractive in all cases, depends critically on the definition of diversification applied.