Everybody loves a bull market. Investors get to feel the comfort of higher returns, and asset managers are able to ride the wave.
But when everything is going up, it’s also difficult to tell whether funds are doing well because of manager skill, or simply because the market is so supportive. This distinction should however become more apparent when times are hard, as they have been in South Africa for the past five or six years.
“It calls for a greater skill set than just running with a strong market,” says Natasha Narsingh, portfolio manager of the multi-asset SIM Managed Solution Fund Range and head of SIM Absolute Return Funds. “In that kind of environment, you can’t really discern the different skill sets of managers. But this kind of market requires you to be much more astute in how you manage the opportunity set.”
Above and beyond
For Narsingh, this includes looking at a range of difference sources of possible return.
“You have to be looking for new opportunity sets, and searching further to increase your probability of achieving your investment goals,” she says.
“You can’t only look to the traditional asset classes and types of investments that you could rely on in the past. You need to push the boundaries.”
In particular, this means looking at alternative ways of managing risk, and introducing more defensive strategies into a portfolio. This includes the use of derivatives, but also assets that are more defensive in nature.
“For instance, we’ve been looking at real assets in the listed offshore space, which give you access to companies with growing income streams linked to inflation,” Narsingh notes. “We’ve also tapped into different types of infrastructure assets, and property assets that are associated with more stable types of rental agreements that we don’t have in South Africa to provide uncorrelated sources of returns.”
The right mix
How managers put all of these assets together has also been critical. Particularly in the local environment, a willingness to be overweight local bonds has paid off for managers who successfully identified the opportunity to earn good real returns in this asset class, particularly when local equities have underperformed.
“The nice thing is that if the lower-risk assets like bonds are giving me higher returns than the high-risk assets like equities, then it’s quite an easy decision where to invest,” says Philip Bradford, manager of the Sasfin BCI Balanced Fund.
These asset allocation decisions, he believes, have been the key differentiator over the past few years.
“If I was more of a stock picker, it would be very tough to be sleeping at night because what everyone since Harry Markowitz in the 1950s has been telling us is stock picking is hard to do,” says Bradford. “I think it is becoming far more important to get the asset allocation right.”
This is particularly true because South African investors and fund managers tend to naturally be overweight equities.
It can be something of a mindshift to put higher allocations into fixed income assets.
“I think people’s expectations were set by the very high returns in the 1980s, 90s, early 2000s in equity markets, which were unfortunately seen as normal, but were actually significantly above average,” Bradford says. “Normal returns for US equities in a much higher inflation environment are 6% to 7% per year. When inflation is 1%, you can probably expect 5% from US equities. That’s fine if that’s your inflation rate in the US, but it’s not so great in South Africa where inflation is 4% or 5%.”
When comparing asset choices in the current environment, Bradford believes that anyone following a strong risk management process is going to be at an advantage.
“When you follow more of an asset allocation process rather than a stock picking process you are by your nature more risk aware because you are constantly comparing high risk assets to low risk assets,” Bradford explains. “And if the expected return on high risk assets is not much higher than that from the low risk assets, then you don’t need to go there.”
For Narsingh, this is all part of successfully assessing the situation, and executing an appropriate strategy.
“Something we also tend to forget in a high return environment is that you need to have different gears,” she says.
“In a lower return environment you need to be more agile and willing to switch to a lower gear, focus on risk reduction, be more tactical in your asset allocation calls, and know when to call it quits on your losers and deploy that capital elsewhere.”
The Sasfin BCI Balanced Fund was recognised as the best moderate allocation fund at this year’s Morningstar Awards. The Sanlam Investment Management Managed Moderate Fund of Funds was runner-up in the category.