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Looking for ‘patient capital’

Dr Adrian Saville, an investment specialist at Genera Capital, discusses his recent change of career, new focus and his thoughts on cryptos.

RYK VAN NIEKERK: Welcome to my weekly Market Commentator podcast, where I speak to leading asset managers and investment professionals in South Africa. My guest today is Dr Adrian Saville. He has been in the asset management industry, well, since forever. He has been involved with many different businesses, but he is best known for being the founder of and chief investment officer at Cannon Asset Managers for 17 years. He resigned earlier this year and joined Genera Capital as an investment specialist. Of course, he’s also an academic where he wears many hats, most notably as a professor in economics and finance at Gibs.

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Adrian, thanks so much for joining me. It has been six months since you’ve left Cannon. Any regrets?

ADRIAN SAVILLE: First, I had to smile when you said I’ve been in the investment industry ‘forever’.

RYK VAN NIEKERK: When did you start?

ADRIAN SAVILLE: I guess you’re right – my entry into the investment industry was as a teenager building fictitious portfolios and then some initial capital, which I invested. We would grandly call this PA, personal account. I started working in the investment industry in an investment syndicate in 1994, an investment club. That led to the licensing of a business, or gave me the capacity to form a licensed business – and that was in the late 1990s. But I’ve been with Genera Capital, as you say, over the last six months. Your question was, “Any regrets?” and the very short answer to that would be “absolutely none”.

It’s a very different part of the industry. It’s a new opportunity to work with individuals in a multi-family investment office, a new landscape, a new terrain, and I am loving the experience.

RYK VAN NIEKERK: Are you still a shareholder of Cannon?

ADRIAN SAVILLE: No, no, no. That transaction which we did (was) in 2017 and I exited my shareholding then.

RYK VAN NIEKERK: Genera – you’ve just briefly said it was a pretty niche asset manager, but I can’t find any fact sheets about the funds. What do you do there actually?

ADRIAN SAVILLE: If you’ve visited Genera Capital’s website, (you’ll see) Raymond Goss as the founder, with Tristan Retzlaff. They are the principals in the business. Raymond is well known to the South African investment industry, and increasingly the global investment industry. Tristan is based in London. And the business is described, I think, in a statement as a ‘multi-family investment office’.

RYK VAN NIEKERK: What does that mean?

ADRIAN SAVILLE: It means we look after families. That’s the principle that we’re looking after. The fact that we’re looking after families of itself will give you a sense that we are looking after high net worth (people) and essentially helping them solve for international global investment demands, challenges, needs. We run a fund called the Genera Optimal Fund. That’s a global multi-asset solution, and that is licensed under Stenham. And we are in the process of working with FSCA’s (Financial Services Conduct Authority) blessing, licensing a domestic solution.

RYK VAN NIEKERK: What you do is you look at high net worth individuals, probably their family trusts, the instrument where the assets are housed – and manage those per portfolio. Or do you actually bundle and try to have a more generalised and possibly a more cost-effective solution?

ADRIAN SAVILLE: I think that’s perhaps a first in a critical point of distinction of where I’ve been historically. As I said, the move to Genera Capital for me was a significant change in my career footprint or profile, having been for all of my career inside an investment-management firm, this is very much about wealth management and advisory.

That’s a substantial shift. What I’ve quickly come to appreciate is there is no such thing as a generic solution – and that’s not a play on words, a half pun. Every family has a unique circumstance, a specific need, and so our role is to help them solve for that family need. The fact that it’s family will also give you a sense that it is multi-generational, that we are not trying to solve for next quarter’s investment return but we are trying to build what perhaps is a good term here, ‘patient capital’.

RYK VAN NIEKERK: ‘Patient capital’ – that’s an interesting term. How actively are you involved with investment decisions?

ADRIAN SAVILLE: Well, if you look at the investment solutions that we’re building, the core is a multi-asset investment solution. I have lots of experience in looking after multi-asset. The portfolio solutions that I’ve described, you’d appreciate are global multi-asset, and you could sort of read through that and infer that that is in dollars. But of course some of our investors have euro solutions or sterling solutions. So that’s the specific family solution.

Alongside the multi-asset as the core, there’s the capacity to put in a tail, where the tail will produce results very different from market results. And the tail might be to protect against downside or to gather upside. Indeed we’ve just hosted recently one of our tail managers talking about how they protect against downside risk.

So these are multi-asset solutions, where in our investment construction what we regard as I think sort of the two principal investment challenges or investment threats, number one is downside risk – that you need to protect against downside risk. And challenge two is probably the single greatest confiscator of wealth and that’s inflation. And so that’s how the portfolios, the investments are built against that backdrop. And if you’ve managed effectively for those, our experience over the five years that we’ve been running the portfolios is that you can actually achieve equity-like returns with bond-like volatility.

RYK VAN NIEKERK: You can achieve equity-like returns with bond-like volatility.

RYK VAN NIEKERK: How do you do that?

ADRIAN SAVILLE: Well, non-correlated assets I think are the point of departure; a first, non-correlated assets. What that means is that where you’ve got market volatility, downside volatility, if you’ve built a portfolio with effectively de-correlated assets, when the market draws down 30%, as it did in the early parts of last year, our portfolio is going to draw down 10%. That’s exactly what it did, which means you reset as the market recovers; your 100% hasn’t fallen to 70%, your 100% has fallen to 90%, and so you start building off a much higher base. That means that your recovery doesn’t have to be equity-like recovery. It can actually be far more stable, far more careful capital.

RYK VAN NIEKERK: The market rebounded by 50%-plus, so that you get the full magnitude of that recovery.

ADRIAN SAVILLE: No. But if you’re recovering off 90%, you don’t need the 50% recovery. So you need the 50% recovery if you’re recovering, or for drawdown to 70%. But by virtue of the fact that you have drawn down much less means whatever you grab back on the upside, your upside capture doesn’t need to be that full participation if your downside capture hasn’t been that full participation.

So out of that, you actually get much, much lower volatility, but you get participation in full capital growth. So perhaps you do need these fact sheets in front of you, the global fact sheets, for me to evidence to you. I think the powerful proposition of effective diversification – and here maybe this takes us into the investment conversation more fully – is very often from a South African perspective, and although the capital we’re looking after is global, I’ll use the South African example.

When you’re looking at the way portfolios are built from a South African perspective, it’s imagined that if I own US equities I’ve internationally diversified. And we need to remind ourselves that this single global asset class ownership is not diversification, that there are times when the dollar has not been the most favoured currency, that there are times when equities have fallen into a state of abandonment.

Think of the 1970s and into the 1980s, where equities were an un-ownable asset class. If you owned US equities in the 1970s and eighties, you were in one of the most unfavoured asset classes. But now if you talk to many investors about their portfolio positioning, they will talk about their US equity portfolio.

RYK VAN NIEKERK: That is a very interesting approach. But let’s look at the US market at the moment. I think the Standard and Poor’s index has hit, I don’t know, virtually on a daily basis in the past few months, all-time highs. So what is the risk profile from your capital preservation perspective. How do you invest or how do you handle it?

ADRIAN SAVILLE: That’s a great question. From a portfolio construction perspective one of the big risks is that you get left behind an euphoric circumstance such that to the extent we are cognisant of the market footprint and we’ll construct our portfolio, recognising the size of global capital allocation to the US for instance, but also to Europe, to Japan and others. We will moderate that by economic footprint, because you can have a market that entirely disconnects from its economic footprint.

Let’s not talk about the US. Let’s use Japan as a case in point. In the late 1980s Japan represented 50% of world market cap, but only 10% of world economic output. So there’s a hint there that there might be a disconnect. And indeed, the way that that came to pass is the Nikkei fell 80% from that late 1980s/1990 peak over the next 20 years. And so, if you were a Japanese equity investor, you might’ve been enthralled by the prospect of Japan in the late eighties, only to be spectacularly disappointed. Was Japan an economic basket case? No, not at all. In fact, Japan has continued to be a very prosperous and competitive economy. But from an investment perspective, you had massive overvaluation.

If we use that principle to look at the US right now, it won’t be lost on you that the US speaks for about one-fifth of world economic output, but about one-half of world market cap.

So there’s a sense that there might be a disconnect between US valuations, and in the same breath you’ve got China, which is powering ahead and looks set to overtake the US in terms of nominal GDP, but isn’t remotely that size in terms of market cap. So if you put more than just market cap into the analysis, I think it offers a fuller perspective.

RYK VAN NIEKERK: That’s a very interesting view. But it comes back to a question: when does a long-term diversified investment strategy become a wealth-preservation type of strategy where the focus is not on peer growth any more?

ADRIAN SAVILLE: Just to rewind the two risks that I flagged early on in our conversation: risk one is permanent destruction of capital. Let’s say you were a Japanese family investment business, and you had allocated all of your capital to Japanese equities, which were the superstar of the late 1980s. Over the next 20 years, even if you were a superb equity investor in Japan, you would have lost 80% of your capital. Now that’s not permanent destruction; that’s rather spectacular destruction of capital.

The second is inflation, and inflation eats while you sleep.

So here let’s go to the experience of the US, of the UK in the late 1970s – the so-called ‘winter of discontent’ where the UK got into 15 and 20% inflation. Now these times are long forgotten. We don’t imagine that it’s possible for an advanced economy to print 20% inflation, but I think investment management is asking the question: What if it does? If it does under that scenario, what would our portfolios look like?

So a multi-asset solution caters for these risks. How do you cater for those risks? You don’t own just equities. You might have some equity in your portfolio, but you’re going to own government bonds, you’re going to own precious metals, you’re going to own commodities which do very well in an inflationary environment, and you’re going to own inflation-linked bonds. So that’s a much fuller diversification than a conventional sort of 60:40 portfolio, which has got 60 equities, 40 bonds.

So we’ve got double-digit ownership of precious metals in our portfolio. We own inflation-linked bonds and commodities – which are fantastic defences against inflation – and we own equities; and those commodities will also participate in a growth environment. So I think this portfolio construction looks after this ‘patient capital’ very mindful of what I would call these primary risks of permanent destruction and inflation.

RYK VAN NIEKERK: Private equity and property – you didn’t mention those. Are they within the portfolios?

ADRIAN SAVILLE: I didn’t mention those, and perhaps that’s part of my new experience and learning in a family office. For the last four or five years I’ve chaired the investment committee of a South African venture capital business, or Section 12J business, called Meta Capital. What that has demonstrated is just how different the investment and return profiles of venture capital are, and equally private equity. So in part of our satellite offerings we have access to some really compelling private-equity and venture-capital opportunities.

RYK VAN NIEKERK: Then, just lastly, the local market. We did rebound strongly since March last year, but over the past few months we’ve been moving sideways – maybe a ‘volatile sideways graph’ would be an apt description – but the international markets have continued on an upward trajectory. What are your views on the current valuations and the possible future direction of our local market?

ADRIAN SAVILLE: When you say international markets have pushed ahead, of course the US has pushed ahead. But if you’ve been a European investor for the last 10 years, it’s been sideways. So I think international experiences have been varied.

Domestically what speaks volumes is the way mid caps and small caps have sat up over the course of the last six, 12 months. There is a base effect but, even then, they’ve given more than they took away. So there’s some quite nice opportunity that has sat up in that slightly off-the-radar environment of mid and small caps.

For me, I guess, the real tragedy in the South African circumstance is the ambivalence of policy. What investors are constantly on the lookout for is policy certainty, and we’ve got this flip-flopping in the policy narrative, as you well know, with this green paper of the last couple of weeks suggesting that there’s a 12% payroll available for a universal pension fund. This came from left field, and it really injects a bunch of uncertainty into an environment where investors are desperately looking for policy certainty.

I was in a conversation earlier today with an academic colleague in Rwanda, and she tells me that every two weeks (President) Paul Kagame comes onto public media and gives clear direction of what the next two weeks looks like from a lockdown perspective, a vaccination perspective, an economic mobility perspective – and ‘I will see you in two weeks’ time’. He speaks to the Rwandan population every two weeks with regularity. By contrast we’ve got a lot of noise in our policy. We’ve got this green paper. Sometimes the president speaks, sometimes he doesn’t. I think that that is snatching victory from the environment, perhaps stuffing defeat into the jaws of what is possible. The South African environment has been heavily influenced by the goings-on in Prosus and Naspers – heavily influenced.

RYK VAN NIEKERK: As you say, I think the poor performance of those counters has actually hidden the excellent performance of mid caps and specific sectors – the financial sector.

Asset allocation geographically, how much do you actually look at the local market?

ADRIAN SAVILLE: I’m responsible for domestic asset allocation and global asset allocation. It’s hard to find a case for bonds. It’s even harder to find a case for corporate bonds. Domestically there are some attractively priced assets, and I’d say almost the exact opposite domestically – that in a tame inflation environment, nominal bonds and inflation-linked bonds are attractive. They’ve delivered almost double-digit year to date. They still look attractively priced.

Inside of equities there remain some very compelling cases, but I think you need to be careful about where you go.

It’s a case of finding the good assets and being satisfied that their drivers are in place. Commodities have really sat up.

Have a look at the performance of some individual counters. Sibanye is a great talking point. What an absolute rockstar and a superbly managed company! I don’t want to take anything away from the management, but can the tailwind of commodity prices stay in place? That’s a harder case to make; it’s a much easier case to make about their management. Just a superbly managed business. But it’s a harder case to make that the commodity tailwind will be in their favour for the next 12 months.

RYK VAN NIEKERK: Just lastly, do you see cryptos as an asset class?

ADRIAN SAVILLE: Would it be funny if I shared with you that I bought my first non-fungible token on the insistence of my son? [Chuckling] So I’ve ventured into that water only so that I’m not an armchair critic. But I’m on the field. I bought some Ethereum, we bought a non-fungible token (NFT). I’m trying to figure this out. I don’t understand it. It’s esoteric, it’s quirky. I can’t get my head around how you value something that has no intrinsic underpin. So can I reserve judgment for now while I experience my first investment in NFTs?

RYK VAN NIEKERK: I delivered a guest lecture at an MBA school not too long ago, and one of the case studies I used was, “Listen, say you get R100 000. What would you do with it?” Many people said, “Buy equities, pay down the mortgage bond”. And then 50% of the people, 50% – and these are mostly young professionals – said they would buy crypto. So there is definitely a value perception among maybe a younger generation.

ADRIAN SAVILLE: It has captured minds and attention – a good reason to put a question mark over many central banks and their ability to print money. In a fiat currency world the printing of money debases it; that’s evidenced by inflation. So I share that concern, the cynicism.

But what I can’t get my arms around is how you value this thing? If you can’t value it, how do you regard it as an investment class?

RYK VAN NIEKERK: How do you value gold?

ADRIAN SAVILLE: Fair comment, fair comment. In that landscape, if you are going to put gold into your portfolio, then if you do a market-cap equivalent you should probably own the equivalent of half of whatever your physical gold position, that should be  in crypto, if you’re going to go on that basis. I don’t want to dismiss it. I think that might translate into a spectacular soundbite in my investment career: ‘Here’s the guy who said crypto was worthless.’ But it’s really hard to work out how you value this thing. Where I’m spending my investment time in this terrain is to work out how it works, how it behaves, how you value this thing fundamentally or intrinsically.

I can volunteer that I’m making some headway, but I would hardly call it an assault case.

RYK VAN NIEKERK: Well, I think once you have skin in the game, your perspective might change, and [you might find] it’s actually quite interesting.

ADRIAN SAVILLE: I’ve got my wooden non-fungible token. Maybe a statue.

RYK VAN NIEKERK: Adrian, thank you so much for your time today. That was Dr Adrian Saville, an investment specialist at Genera Capital.

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I don’t think you can look at USA GDP vs USA market cap and call that market expensive as all the major US companies with massive market cap generate a significant portion of their earnings offshore. In addition, if you look at US corporate profits relative to US GDP, it’s at all time highs, which supports a higher market cap vs GDP.

The man’s record is terrible.

Adrian is no doubt a high IQ guy. It doesnt and hasnt translated to meaningful performance for his clients at Cannon. What does he propose to do differently going forward for Genera.? Its a difficult game to generate alpha over long periods.

AH but let me guess; his personal nett wealth is pretty good?

You have to go back to non-usury days in the Christian and Islamic world to find patient capital.

Those days are over.

They could come back but you have to beat the usury and rehypothecatuon addicted money lenders.

End of comments.

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