Towards the end of 2015 Nedgroup Investments announced that it was replacing RECM as the manager of the Nedgroup Investments Managed Fund. After years of chronic underperformance, their patience finally gave out.
To September 30, 2015, the Nedgroup Investment’s Managed Fund was the worst performer in the South Africa multi-asset high equity category over one year, three years, five years and 10 years. This was also far from the firm’s only disappointing display. RECM’s performance across all its funds had been noticeably poor for some time.
As the graph below shows, the RECM Equity Fund was delivering significantly negative returns over a period when its peers and the market were positive.
Source: Morningstar (Click to enlarge)
This led to both a substantial drop in the value of its funds, and to large withdrawals from investors. Between June 2014 and June 2016, the assets under management in RECM’s unit trusts more than halved from R5.9 billion to R2.5 billion.
This coincided with a period in which value investing substantially underperformed as a style. As a value investor, RECM was heavily impacted. However, executive chairman Piet Viljoen acknowledges that this was not the primary reason for the firm’s struggles. What went wrong is that RECM deviated from its investment process.
“When I started the firm 2003, we worked from the point of view that we couldn’t know everything about everything,” says Viljoen. “So what we tried to do is build diversified portfolios of fairly uncorrelated, cheap situations, some of which would work out and some of which wouldn’t. But if a few of them didn’t work out, it wouldn’t sink you.”
Over time, however, this changed. A combination of what Viljoen acknowledges as ‘overconfidence’ and transferring more responsibility to younger members of the investment team, led to changes in how RECM built its portfolios.
“The process morphed into a high-conviction, deeply-researched, large-position type portfolio,” Viljoen says. “In my opinion, that was a mistake. I allowed it to morph from an environment where you hold your beliefs lightly and don’t bet the house on one particular outcome, into one where you take big bets on high-conviction ideas, which are very well researched and thought through, but if they don’t work the portfolio stinks.”
2016 to 2018
Over the long term, a high conviction portfolio with a few large holdings can work extremely well. Over the short term, however, it can result in significant volatility. Particularly when this occurs to the downside, it becomes difficult for investors to withstand.
“We underestimated how much this would hurt our clients,” Viljoen acknowledges. “You can say that they just have to sit through it, but it’s extremely hard to do.”
RECM was therefore forced to look at what it was doing, and go back to the process it had originally been known for. Fortunately for the firm, this coincided with a period in which value investing found more traction in the market.
“In 2016 there was a rebound for value stocks from a very oversold situation at the end of 2015,” Viljoen explains. “There had been panic around resource stocks in general and platinum stocks in particular, and they got ridiculously cheap. We stayed with our positions in that part of the market into 2016 and those stocks rebounded strongly.”
The following year was less rosy for RECM as large stocks like Naspers drove market returns. However, in 2018 many former market favourites took some substantial hits, once again creating opportunities for investors with a more contrarian view.
“It started with Steinhoff, and was followed by Aspen and others,” says Viljoen. “We didn’t own any of them because they were overvalued.”
The value of value
The result is that for the three years to the end of December 2018 the RECM Equity Fund was the top performing general equity fund in the country. For the 2018 calendar year it was one of only two South African equity funds that showed a positive return.
Source: Morningstar (Click to enlarge)
The RECM Balanced Fund was also in the top 15 performers in the multi-asset high equity category for 2018.
Viljoen is quick to acknowledge that it would be presumptuous to claim that this all has to do with RECM being clever.
“There’s so much luck involved that it’s difficult to disentangle what is luck, what is skill and what is the market,” he says. “I wouldn’t want to claim that it’s all skill.”
It is, however, evidence of a good value investment process working. In a difficult market, value should provide investors with some defence.
“Generally in good times we make less money than most others because we don’t own the popular stuff – the rock ‘n roll assets,” Viljoen says. “In bad times we lose less or even make a bit of money. If you put those periods together it gives you a satisfactory outcome.”
When RECM was underperforming so badly, it was not fulfilling this role. The last few years have however delivered signs that it is showing the ability to do so once again.
“Classic value funds are very different from the index and very different from the average fund,” Viljoen argues. “We are of the opinion that they can play a very important diversifying role in most investors’ portfolios. If I were constructing portfolios today, I would have a large portion in index funds, and allocate around the sides to something very different like a value fund.
“You never know when the value cycle is going to do well or badly,” he adds. “In hindsight it’s always very clear, but before the fact you just don’t know. It’s best to pick your asset allocation based on sensible assumptions and stick with it.”