Making the case for flexible funds

By limiting downside losses they are able to outperform in tough times.

This article was first published in the latest issue of the Moneyweb Investor. To read the magazine click here.

South African multi-asset flexible funds are underutilised, misunderstood and unloved. In fact since 2012 funds invested in this category have fallen from 6% to 3% of assets under management (AUM). In comparison, funds invested in the South African high equity space have ballooned from R146 billion, or 15% of AUM to R414 billion or 23% of AUM.

This makes sense. Historically over time equities deliver the best returns and between 2009 and late 2015 investors in the JSE enjoyed a sustained bull run. In addition most equity funds are regulation 28 compliant, which makes them easy to slot into retirement funding vehicles.

hat said, in today’s volatile and unpredictable world, there is definitely a place for flexible funds, says Francis Marais, research and investment analyst at Glacier. Of the twenty top performing unit trusts – measured over ten years up until April – nine were property funds and four were industrial funds. But it is noteworthy that four were flexible funds. See story here.

It was for this reason that Sanlam’s Glacier Investment invited five flexible fund managers to address clients and independent financial advisors. 

The category remains small, with just 70 funds (out of a possible 1 350) following a flexible approach. The funds themselves are relatively small with the likes of Bateleur Flexible Prescient Fund managing R936 million, Laurium Flexible Fund managing R1.9 billion, PSG Flexible Fund managing R7.7 billion, the Sanlam Select Flexible Equity Fund managing R3.9 billion and the Truffle Flexible Fund managing R4.6 billion. In comparison, the biggest fund in the industry is the Allan Gray Balanced Fund with R114 billion in AUM.

What’s the attraction?

The primary investment objective of flexible funds is to preserve capital while maximising returns over the longer term. To achieve this goal the fund manager has the flexibility to vary the asset allocation between equities (so-called risky assets) and interest bearing instruments (for example cash and bonds) as conditions require.

“It’s about fighting without your hands tied,” says Marais. So when equities are not compensating for the risk, managers can switch asset classes. Over tumultuous times that ability to contain their risk makes them a much better investment vehicle. “Capital preservation is important. Bear in mind that if your investment falls by 50%, you have to make back 100% just to recover your position,” he notes.

The only limitation in the case of the South African flexible funds is that 70% of assets must be invested in South Africa. Pure equity funds have to hold a minimum of 85% equities and always have to be fully invested. No matter what the stock market is doing.

Flexible fund performance over time

 

 

YTD

1 month

3 months

1 year

3 years

5 years

10 years

PSG Flexible

10.36

0.72

8.02

6.57

14.72

15.32

15.41

Truffle Met Flexible A

3.16

5.94

7.49

10.75

17.91

18.87

 

Bateleur Flexible Prescient A1

3.46

5.21

8.12

12.39

18.02

19.62

 

Laurium Flexible Prescient A1

2.41

3.93

7.79

9.37

19.29

 

 

FTSE/JSE

TR ZAR

7.57

1.84

10.23

6.25

11.98

14.04

13.34

(ASISA) South African MA flexible

4.13

2.26

6.69

3.95

9.86

11.60

10.65

 

 

                 

Source: Morningstar

Size matters

The combination of flexibility and size means that the fund managers are able to enter and exit positions relatively quickly. “The smaller you are, the easier it is to take advantage of volatility and the more alpha opportunities there are,” says Truffle portfolio manager Jonathon du Toit. “We bought banks on the Friday after Nene was fired and sold them on Monday at a 25% profit.”

But being opportunistic comes with certain provisos. “You have to be careful that you are not too aggressive with your views. For instance we believed there was a 65% likelihood that the UK would stay in the European Union,” says Laurium portfolio manager Murray Winckler. “But before you translate this into portfolio decisions one must bear in mind that this a very volatile time with many such decisions to be made.”

The case for cash

The combination of slow global growth, low interest rates, loose monetary policy coupled with unstable politics has created an uncertain investment environment.

“This global uncertainty means investors have massive amounts of cash on the sidelines,” adds Matthew Auerbach fund manager at Capricorn Fund Managers (which manages Sanlam’s flexible fund). “Investors will deploy this as opportunities emerge.”

All of the fund managers have fairly high cash balances at the moment. Cash holdings vary from 25% at Bateleur to 14.5% at Laurium and about 9% at Truffle.

The value of cash is under appreciated and only recognised when you need it most, says PSG fund manager Shaun le Roux.

For the first time in years, carefully deployed cash is offering good opportunities to enhance yield. For instance bank NCDs (negotiable certificates of deposit) are highly liquid and some are yielding 8%+ – a fact that flexible fund managers are taking advantage of.

Offshore allocation

While cash is looking relatively attractive, offshore stocks are looking less attractive than they were, with most of the fund managers pulling back from their full allocation. Laurium, which chooses to invest offshore via ETFs, has only 15% allocated offshore and of this 11% is invested in SABMiller. “At least 80% of active managers underperform the S&P 500 over ten years – so we take the passive approach,” says Winckler.

Laurium also has a strong Africa capability. “We are in Africa at least once a month,” he says. “So you get a feeling for what is really happening on the ground. As a result of these insights we shorted Tiger and Nampak two years ago.”

Capricorn also has in-house emerging market expertise and as a result the fund holds some interesting ‘below the radar’ investments – a Mexican airport operator for instance.

Domestic equities

While flexible fund managers can choose to exit equities when it gets too hot, there is no doubt that strong stock-picking capabilities help differentiate the good from the mediocre.

And like all equity fund managers, views differ on whether stocks like SABMiller, Naspers and BAT, which are trading at lofty price multiples, offer value. “There is a perception that we don’t like rand hedge stocks. We have owned lots in the past,” says Le Roux. “We have bought BAT, SAB, PNP, but all at 10 x earnings. Right now we own none of these. We have managed to outperform the Alsi without either SABMiller or Naspers in our portfolio.”

On the subject of resources and property, there is lots of caution. “We are very cautious of property,” says Le Roux. “Property yields are low relative to government bonds. And property’s domestic fundamentals are deteriorating. Companies are over-gearing and are in a big rush to externalise capital.”

Skin in the game

One last feature of these funds that investors may appreciate is that their fund manager is generally invested alongside them, which means they have aligned interests. Truffle takes it a step further and staff cannot invest in any stocks or funds outside of the Truffle universe.

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