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Slogging it out, one run at a time

What the fund managers say.

This article was first published in The Investor. Read the full magazine here.

The beauty about multi-asset, high-equity funds is that fund managers have the flexibility to invest in different asset classes – equities, property, bonds and cash – in response to changing market circumstances.

Many investors look to multi-asset funds to provide a lower-risk investment than a pure equity fund, but with greater prospects for growth than a pure bond fund.

What becomes evident in conversation with high performing fund managers’ from Truffle, PSG and Rezco is that they have several characteristics in common. They are all bottom up stock pickers. They invest in companies with competent management teams, strong balance sheets and high barriers to entry. They rely on fundamental research to make their selections, and seldom follow the herd. Index trackers are either not used at all, or used selectively.

There are also notable differences among them, specifically in the area of asset allocation.

Rob Spanjaard, portfolio manager of the Rezco Managed Plus fund says that the fund has relatively low invested levels at the moment.

“We are in cautious mode. We think valuations locally and in markets such as the US are horrible. There are opportunities but you have to work hard to find them.”

Risk assets, in other words local and offshore equities and property amount to 45% of the fund, which is at the low end of the range. The balance is held in bonds and cash. “We are not waiting for Armageddon. If we were, the risk holdings would be at zero. Rather we have cash on the table and will wait for opportunities to present themselves.” 

Over the last couple of months the PSG Balanced Fund has upped its allocation to domestic equities from 58% to 63% of the fund. “As share prices pulled back we started seeing the companies we like to own at more attractive prices,” says fund manager Paul Bosman. “They are not cheap enough to be big positions in the fund yet, but we are adding.”

The fund is fully invested offshore (up to a max of 25%) and Bosman has recently made added a small stake in government bonds. “You are starting – to see a real yield of 2 to 2.5%. This also serves as a hedge against disinflation,” he says.

Truffle’s Flexible Fund has 52% of the fund invested in local equities and property and 14% in offshore equity, bringing the total investment in risk assets to 66%.

Fund manager Iain Power points out that while the going is tough, to achieve a return of inflation plus 4% one needs exposure to risk assets. “These are the assets that generate inflation beating returns,” he says.

Rezco’s Spanjaard is keeping a wary eye on offshore markets. Just 10% of a possible 25% is invested at present. “We are concerned about US markets. We think the US recovery is already late cycle and the Fed is behind the curve with rate hikes. Costs are rising fast, the dollar is strong and this is putting pressure on earnings.”

US companies have been investing about $600 billion/year on share buy backs using low-interest borrowings to do so. “This is problematic in the face of rising debt costs and it could be messy as it unwinds.”

The other problem potentially is China, he says. “The government is not dealing with bad debt at all. It could turn out to be benign or toxic and we are not sure which it is.”

Inflation, or disinflation in the domestic market is a concern. “There are structural forces that are disinflationary,” says Bosman. “Globally we are seeing surplus capacity in industries from resources to manufacturing. The same applies in South Africa. Demand is not growing fast enough to close that gap, so there is limited inflationary pressure. Globally this could result in disinflation.

A big worry is the ability of South African businesses to continue to grow earnings in real terms. “We think earnings over the next few years will surprise on the down side,” says Power. “In addition price:equity ratios are high relative to the long-term median. A combination of high ratings plus potential for earnings disappointment means the beta benefit of the last five years will not be repeated. Markets will track downwards or sideways until earnings catch up with ratings.”

In this environment stock picking becomes paramount.

Truffle has recently added British insurer Lloyds to its portfolio, which offers an attractive 4% dividend yield in sterling. It has also added China-based internet company NetEase, which is a competitor in the gaming space to Tencent.

PSG’s Bosman is dipping his toes where others fear to tread. A conservative 6% of the fund is invested in miners such as Anglo American, Billiton and Glencore. “These are companies with reasonably strong balance sheets and proven management teams. While these cycles tend to be deep and sustained, remember that we are buying these shares with a time horizon of at least five years – to November 2020 and beyond.

The fund has also invested in companies that service the oil, gas industry or mining industry and are being sold down aggressively. US-based Colfax is one of these. “It has a strong balance sheet but is very unloved at the moment,” Bosman says.

Investing right now is like one of those horrible low scoring games where the game is won by the team prepared to slog it out for a single here and a single there.

“If you are patient it comes to you,” says Spanjaard. “Keep an eye out for the buying opportunities. Foreigners own half our market. As they lose interest, prices will come down creating buying opportunities. They are selling on a daily basis but we still think the market is 20% over valued.”

In this environment achieving the 19% to 20% annual returns of the past few years will be impossible. Instead returns in the order of 12% to 14% would reflect a good innings, they say.

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