The general belief is that the more choice you have, the better. Many investors are drawn to worldwide flexible unit trusts for this reason – these funds can invest in any asset, anywhere in the world.
In theory, flexible fund managers are always able to select the most attractive investments for their portfolios. The have a completely unconstrained mandate.
Yet the first choice that successful managers make is almost always to narrow their choices. Having complete discretion to invest across markets and asset classes may sound liberating, but it is more of a distraction than a benefit if you don’t know what you are looking for.
What’s the plan?
When your opportunity set is so wide, it is crucial to have the discipline to stick to a clearly-defined process that will identify the right kinds of investment opportunities. This has been particularly important in the current uncertain global environment, where markets have continued to defy expectations.
“Over the past few years it has been a challenge sticking to the types of businesses we prefer, which are high-return companies,” says Richard Pitt, portfolio manager at Blue Alpha and manager of the Select BCI Worldwide Flexible Fund. “It’s no surprise that those are businesses you have to pay up for, and we have faced a lot of questions about whether we are paying too much.
“Common sense in the investment world is that you want to buy cheap.”
Over the last five years, however, buying cheap assets has not necessarily been a successful strategy. Value as a style has been through a long period of underperformance.
“What we prefer to do is to look at the history of a business and ask if the returns it is generating are sustainable,” says Pitt. “There is a lot of research that shows that business returns are a lot stickier than many investors imagine.”
He adds: “If a company has high returns, and it has areas in which to invest and grow, the impact that has in terms of what it can generate for investors is much higher than people think. It challenges the simple notions of valuation.”
This approach, Pitt argues, also does not rely on a particular future outcome – for instance, a reversion to the mean.
“Our sense is that if a business is dominant in its industry and still has growth ahead of it, and has high returns, our best bet is that that will continue for the foreseeable future,” he says. “Things do change, of course, but across a portfolio they are not all going to change overnight. So rather than predicting the future, our job is more to observe what is happening and take that on board.”
This approach also helps to focus attention away from market noise, particularly at a time when there are so many potential risks in play in global markets.
“We can’t assess all the risks, because the real problems that are going to come up in the next year or three are things we are probably not even talking about,” Pitt says.
“That is the nature of big risks. So you almost have to simplify it and say if I buy good businesses that can grow and reinvest their capital, I should be okay – just so long as I don’t pay completely over the top.”
For Gavin Joubert, co-fund manager of the Coronation Optimum Growth Fund, maintaining discipline will continue to be critical in the coming years.
“Global equities, which have been a big source of return, are less attractive now than they were five or 10 years ago,” Joubert says. “So after this very good decade, I think the environment is going to be more reliant on stock-picking than it has been historically. You have to be even more selective.”
There is also the opportunity to consider different assets that would not have been attractive five years ago. The portfolio he manages has been 90% invested offshore, but there are a few local opportunities that are now presenting themselves.
“The fund has recently bought some South African shares,” Joubert says. “As a result of the problems in the country, domestic shares in particular are hated and one can buy some of them selectively at reasonable valuations.”
Two shares in particular that the fund has been buying are Shoprite and Pepkor.
“These are two of the best assets in the country,” Joubert argues. “They are both largely cash-only businesses, and therefore more defensive. They have been impacted by the economy for sure, but Shoprite still grew its revenues by 10% in South Africa, and you can now buy it at 15 times forward earnings.”
These are the kinds of opportunities that could support longer-term growth for investors, but Joubert nevertheless believes that nobody should expect runaway returns over the coming five years.
The Select BCI Worldwide Flexible Fund was recognised as the best flexible fund at this year’s Morningstar Awards. The Coronation Optimum Growth Fund was runner-up in the category.