RYK VAN NIEKERK: Welcome to this Market Commentator podcast. My name is Ryk van Niekerk, and this is my weekly podcast where I speak to leading investment professionals. My guest today is Victoria Reuvers. She is the managing director of Morningstar Investment Management in South Africa. Most investors would know Morningstar is one of the world’s premier suppliers of financial and investment data. It offers excellent research tools and the information and tools are used by financial advisors and analysts all around the world. Victoria, thank you so much for joining me.
I want to talk about the managed portfolio service you offer in South Africa, which is maybe on the other side of the coin, where you actually develop model portfolios for financial advisors. First, tell us, when did the managed portfolio service launch in South Africa and how has it fared?
VICTORIA REUVERS: Hello Ryk. The managed portfolio service launched just over five years ago. What I’d like to do is maybe just rewind the clock and say, when did the investment management business launch? We’re coming up for six years in February. Now, as an investment management business in South Africa, it’s often referred to as ‘discretionary fund management’ or DFM. For Morningstar, it’s a business that it has been doing for many, many years. And so your introduction was very kind, yes. Morningstar has fantastic data. We have great research. We have wonderful tools. And really the natural evolution from a global perspective was to say – my advisor said to us: you have the data, you know the managers, you’ve got the capital markets’ work, how do you build portfolios for us as advisors that either target a predefined outcome or an inflation hurdle?
The investment management business was born in the US. It has a 27-year track record in the US, and the South African business is a subsidiary or just part of our global investment management business. That was started in February 2015.
What we did when we launched our managed portfolios was to say, for many advisors, they want access to our capital markets work, our research and our portfolio construction, and our tech, but they don’t necessarily want to have the commitment of having to use us or having to have an in-person relationship. They might be based in outlying regions.
So what we did was we brought out these portfolios. We’ve loaded them on pretty much every investment platform, and we use our tech and our tools to enable advisors to access them and to engage with their clients to create solutions or use our solutions to help their investors achieve their goals.
RYK VAN NIEKERK: Do you regard these portfolios as funds under management if an external advisor uses them to compile a portfolio for one of [their] clients?
VICTORIA REUVERS: Yes, that’s correct. So while these are not collective investments, they’re managed on our discretionary licence, and we do earn a fee on assets that are under our discretion. So we do look at the total assets that are under our discretion in terms of assets under advice, or assets under management.
RYK VAN NIEKERK: I just want to understand it perfectly. Say I am a financial advisor, I want to use one of your portfolios. Do I just subscribe and do it in the name of the client, or do I use the Morningstar platform?
VICTORIA REUVERS: It’s a good question. From a Morningstar perspective, we use the terminology ‘we like to work with like-minded advisors’. A like-minded advisor is somebody who also puts the end investor front and centre of everything they do.
And so we do have a slight kind of vetting process, or due-diligence process, if an advisor wants to work with us. It’s really a case of contact Morningstar, and then, once we’ve agreed, all right, you can use these portfolios, we will link you on the investment platforms that you use as an advisor.
So you’re Ryk, and you say, “I use Ninety One one’s investment platform and I use Allan Gray’s investment platform,” and we would link you. And then, when you see one of your end investors, and you recommend a Morningstar portfolio, when you logged onto the system, it would just come up as an option like another fund would, and you would select the Morningstar Balanced Portfolio. It would populate through to the app form, and it’d be as simple as that, just like selecting a different unit trust.
Morningstar Balanced Portfolio
RYK VAN NIEKERK: I’m looking at a document which highlights the holdings of the various portfolios. Let’s look at the Morningstar Balanced Portfolio. It aims for CPI plus 4%, which is pretty decent. Just take us through it. Exactly how should a financial advisor look at this portfolio, and how should [they] take a decision based on the information here?
VICTORIA REUVERS: When you look at our Balanced Portfolio, the one you’ve picked, this forms part of the medium-equity sector. What’s very interesting is, if you look at the Regulation 28 money in South Africa, the majority of money has moved into balanced funds. Balanced funds have played a really good role in serving investors well over time. But over the last five years, they’ve been very disappointing, and for a number of reasons.
One of the focuses has also been on fees. So the way that we have constructed our portfolios is, first and foremost, we leverage our capital-markets research, and then our manager-selection capability. But when we build the portfolio, we build it from a building block perspective. So we select the best managers that we believe will fulfil a role within the different asset classes, be it equity or income or global. And so the result of that portfolio is one that reflects our highest asset-class convictions.
I can take you through some of those at the moment – our highest manager-selection convictions. It has resulted in really strong performance.
If you just look at our Balanced Portfolio to the end of August, it was, net of all fees, up over 9% for the year, which is pretty good in quite a tough year.
But I think, more importantly, if you look at the cost of the portfolio, it’s very, very cheap relative to the sector and relative to other balanced funds. So we’re trying to build portfolios in a very cost-conscious way because every basis point saved is an extra basis point of return that an investor can achieve. But we’re also trying to reflect the best managers in their area of expertise and our highest conviction asset allocation.
RYK VAN NIEKERK: Some of the funds that are included include Fairtree Equity Prescient Fund, the Coronation Strategic Income Fund, and the Ninety One Diversified Income Fund. The fees you charge – are those on top of the fund fees of those fund managers?
VICTORIA REUVERS: Yes, that’s correct. In many cases we charge a flat 20-basis-point fee. We always quote all returns net of fees. And we always quote the TIC, the total investment charge, of our Balanced Portfolio, net of all the manager fees, and net of our fee, plus Vat. So it’s a net TIC, as if you were comparing it to a different unit trust.
To give you an example, we run a living annuity portfolio, called the Monitor Moderate Income Portfolio. This portfolio targets a net income draw of 4% after all fees, and, including all the underlying manager fees and our fee and Vat, it comes in at 91 basis points, which we think is very competitive in this environment for a portfolio that’s got 50% in equities and 35% offshore, and got really good managers, like Fairtree Equity in there, and Aylett Equity Prescient Fund. So we haven’t substituted manager selection for price.
RYK VAN NIEKERK: Why didn’t you just package this into a fund of funds?
VICTORIA REUVERS: For a number of reasons. The first is, as a business three of our founding principles are independence, transparency and long-term investment thinking. And, when it comes to independence, we don’t have our own product. So Morningstar portfolios are really a reflection of a great investment idea, but in a very transparent investment vehicle. It gives advisors the choice to ask, ‘Where is my platform of choice?’ And, ‘Which is the portfolio I’d like to use’.
Let’s say they use the Morningstar Balanced – a very important point, Ryk, is that we have to stack up on merit. So if somebody – an investor or an advisor – chooses not to work with Morningstar, we don’t want there to be any investor impact on exit. So, should an advisor decide, I don’t want to be in the Morningstar Balanced Portfolio any more, but I want to stay in underlying funds, they can notify us. They can disinvest, and there are zero capital gains or transaction costs to the end investor.
Now, if we were to launch a fund of funds or a Morningstar Collective Investment, firstly add another level of fees at the fund level. Secondly, investors have a lack of transparency. Their statement would just say ‘Morningstar Balanced’. They wouldn’t be able to see, okay, I’ve got Fairtree, okay, I’ve got Ninety One in there. And then, thirdly, should they ever wish to disinvest there’d be a capital gains transaction on exit. So we think that the structure of model portfolios provides great transparency. It’s very well priced and it also has got ease of exit and lack of impact should investors ever choose to disinvest.
Recent market volatility
RYK VAN NIEKERK: Interesting. Let’s talk about markets now, just for transparency’s sake. We are now speaking this Friday afternoon on the November 6, 2020, and we have seen an absolutely explosive week behind us – not only politically in the US, but also on markets which reacted very, very interestingly to developments related to the US presidential election.
Just give us a sense of how you see it. First of all, everybody thought Biden was going to take this by a mile. Then Donald Trump’s campaign seemed to be much more successful than many people thought. At one stage people even thought that he could retain the presidency, and this created – I don’t want to say havoc – but definitely some significant reaction from markets. And when it became clear that Biden would win, the number just kept on getting greener.
VICTORIA REUVERS: Ryk, It was never going to be smooth sailing. If there was anything the selection was going to give us, it was going to be tightly contested. There was going to be a lot of drama in this. And I think what it has created and what it has highlighted is just the polarisation in America – in markets as well – and how much on a knife edge everything is.
Markets do not like uncertainty. We know that. And I think it would have been really good if the predictions in the polls had been right. But, to me, the polls are never right, really. They weren’t right in 2016, and I’m not too sure why we follow them so closely. But it’s human nature, I guess. So the worst thing for markets is going to be if there is a very contested election, if Trump doesn’t accept the result, if it doesn’t go his way, and if this thing drags out for too long.
But I think what you are seeing, just based on the preliminary results, it again being Friday where we are, is that it looks like, if Biden is going to win, that the Senate is going to swing the Republicans’ way and that the house will be just a Democratic sort of house. Markets kind of appear to approve of this configuration.
So what it does is that it kind of lowers the risk of much higher corporate taxes because, although if Biden does win, the Senate will be considered controlled by the Republicans. It also creates an environment for much looser monetary policy for a little bit longer.
And so markets seem to be slightly happy, accepting of what’s going on now. You’ve seen that with this kind of strong rebound that we’ve seen in the last few days, and also from a currency perspective.
So, just to kind of unpack, I guess a couple of key points and policy implications. Trump, when it comes to taxes, we know where he is – he’s reduced taxes materially. Biden would like to raise, and he is going to get push-back from the Senate. Healthcare – Trump’s pretty much the status quo, and Biden you’ll see pushing for more Obamacare and public option for individuals. I think the big one is really going to be regulation. So we’ve seen Trump in this role of continued roll back of regulations, and you’re likely to see Biden kind of put in more regulation and stricter environmental rules –but, most importantly his trade policy.
So we know of Trump’s China Wars with the escalated kind of tension, but if Biden comes in into power, we’ll just see much greater global trade, which is positive for emerging markets, positive for the rand, and positive for South Africa.
RYK VAN NIEKERK: Less tension in world trade markets and between the biggest players – that will, I think, calm some nerves. And hopefully you can take investment decisions based on facts and not expectations of what Trump will do in future, and what he will say on Twitter.
VICTORIA REUVERS: [Chuckling] Based on facts, not tweets.
The positives in the SA market
RYK VAN NIEKERK: Exactly. So the local market – we’ve had a dreadful period over the last three or four years, even five years. The market has actually gone nowhere. And this past year, due to Covid-19, a lot of actions taken by many governments around the world also impacted on equity performances. We’ve seen a lot of volatility. But how do you see the local market in the context of South Africans being able to invest anywhere in the world? Why should they invest here?
VICTORIA REUVERS: Being part of a global capital markets team, it’s always interesting to see the views from unbiased US and UK and European colleagues when they look at South Africa through a lens of valuations and not emotion. As South Africans, we do place a lot of emotion. We’ve been very disappointed for many years with policies and measures that haven’t come to fruition – and that’s been reflected in the very disappointing returns. And so, if you speak to any South African and you say, “Hey, the rand could strengthen, and from South African equities we get very strong returns,” you’re likely to be looked at with an element of scepticism and hear “Yes, yes, I’ve heard that before. Very unlikely. I want to take everything offshore.”
But if you just look at some of the fundamental factors, we find ourselves in an environment of low interest rates, which we have not seen in decades, we’ve got a very weak exchange rate, very undervalued currency. We’ve had an element of balance-of-payments stability. We’ve seen an uptick in construction activity. We’ve seen our PMI pick up to a degree. And when you look at the valuations of a lot of our domestic equities, they are incredibly cheap.
So when you take this environment and you say you’ve got very low borrowing costs, very low interest rates, and you’ve got very undervalued equities, it paints a picture for a good next few years for SA equities.
I think the second thing to take into account is, if you’re looking at the investible universe, South African government bonds are a complete anomaly. Now, they’re not without risk, but where in the world can you find an asset class that’s going to give you a 6% real yield, pretty much, if you just buy it and hold it to maturity? You’ve got bond yields of around 9%, you’ve got cash rates of around 3.5%. Do you want an incredibly steep yield curve? It kind of doesn’t make sense.
So the market is pricing in that our government is going to default on its debt. And should the government not default, you’ve got an option to buy South African government bonds, which offer protection against the strengthened currency, and clip a coupon of 9% a year – getting, let’s call it, a 6% real yield each year.
So, when we look at the South African universe, we actually think that there are good, attractive opportunities for South African equities, South African bonds. And then, obviously, we’re not that favourable in terms of cash and/or listed property, although listed property is quite cheap.
So we’re actually pretty positive on the South African environment.
Lack of international investments into SA
RYK VAN NIEKERK: Why do we not see more international investments into South Africa – if that is maybe an objective view of our market?
VICTORIA REUVERS: I think for a number of reasons. One, in the US I don’t think the grass is greener on the other side. I think everybody’s got this sort of tunnel vision of looking at where they are. It’s home bias at the moment, a feeling like if things are terrible in the US, why would I ever take money out and put it in a country like South Africa or in an emerging market?
Everybody’s just taking money kind of back to home base.
So I think globally risk appetite has kind of decreased somewhat.
Secondly, when it comes to our bond market, investors were not very happy with some of the results that kind of came out from Treasury in our medium-term budget speech last year. And so you’ve really seen kind of risk-off trade, as everything has gone back to home base.
But I think [with] a Biden win, you could see quite a quick reversal back into our bond market.
Our equity market’s slightly different. When foreigners buy our equity market, they tend to buy our retailers and our banks. And there we have structural headwinds, so we do need to see some pickup in earnings before I think we’ll see them enter our market again.
But, with valuations at these levels, you don’t need a massive swing for things to change.
You just need the delta of the client to stop being as bad, you need to see things just slowly start getting better. And then you could see quite a change in valuations.
Volatility is here to stay
RYK VAN NIEKERK: Just lastly, we’ve seen significant spikes in virtually every single major equity index in the week we are in. We are now on Friday. This whole week, I think, has been one of the best weeks probably in many, many years. The volatility still will be with us for a long time. How do you see volatility and the local market, because sometimes we can see, for example, the exchange rate change 2% or 3%, and then it doesn’t even make the front page of a major financial website, because that’s just the new normal?
VICTORIA REUVERS: Ryk, I think the concept of long-term investing is often spoken about, but it’s very hard in action in reality, because not only is there access to data on your fingertips, and there’s this kind of desire to look at it, but, whether it’s machine-trading, whether it’s big algorithms driving markets, in the short term people talk about equity funds over one year – and one year’s a meaningless time period. It’s a tiny little time period for an equity fund.
So I think, when you look at markets, you are going to wonder am I a trader, or am I an investor? And, if you’re an investor, then time is your friend and impulsivity your enemy. We would say, look at the news, but don’t really act on it. Make decisions for the long term. The volatility is absolutely something that’s here to stay. Just see a wash of money that is in the system, mainly because rates are so low and, as I said, the systems have changed in terms of the big drivers of investment.
So use volatility to your advantage if you see screaming opportunities that arise; but in the short term, with the swings and roundabouts, let them be water off a duck’s back. They shouldn’t change your investment strategy.
RYK VAN NIEKERK: It shouldn’t change your strategy, but it can change the way you look at asset managers. Of course, Morningstar ranks the asset managers and the different collective investment schemes according to performance, and you do that really, really well.
The thing is, if you look at the current market, you’re going to see some schemes perform like yours, say 9% over the past year; and if you look at another fund that has, say, moved sideways or doesn’t even beat the inflation rate, then if it’s your money it’s relevant and it’s very, very difficult to actually listen to somebody who says, “Sit on your hands; this will work itself out”.
VICTORIA REUVERS: I know. It’s a hard strategy, which is why, when we look at picking managers, performance is really the by-product of a good process – most of the time understanding the process of the manager. And, when we look at the process, we want to look for three things, really: is it a process that’s easy to understand; is it consistently applied and are we separating luck from skill; and does performance match what the process is?
So, if you are an investor, we would encourage you not to chop and change your investments, but to do your homework up front and make sure you’re investing with a manager whose process you understand – and it’s a good process – and it’s a manager that you have faith in … but then to sit with them through their periods of underperformance and outperformance,
…because often in the periods of outperformance, when the money moves to those funds, those are just good ideas that managers thought of and bought those shares many years ago, and the ideas have just come to fruition. And that’s why they’re performing.
Often when managers are performing pretty poorly, if it’s a good manager, that’s actually the time that you want to invest, because that’s when they are buying their good ideas. That’s before their ideas have come to fruition.
As you know, when you look at our portfolios, that’s the reason why we like to blend managers. That’s the reason why we like a PSG Equity with a Fairtree Equity in our portfolio, because they’ve got complementary alpha cycles, complementary investment styles, which means that the actual investment experience is much smoother, so you don’t really have those big peaks and troughs.
RYK VAN NIEKERK: Victoria, thank you so much for your time today. That was Victoria Reuvers. She is the managing director of Morningstar Investment Management in South Africa.