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27four Investment Managers changes tack, hopes to outperform

MD Fatima Vawda looks to unlisted funds for possible above-average earnings in these tough times.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast. It’s my weekly podcast, where I speak to South Africa’s a leading investment professionals. My name is Ryk van Niekerk. Fatima Vawda is my guest today. She’s the managing director of 27four Investment Managers, and has been in the industry for more than two decades. She has seen a lot of action, and 27four Investment Managers is of course a multi-manager; it invests in other funds and they have a very interesting approach.

Fatima, thank you so much for joining me. First of all, we’ve seen so much market volatility this year. How did the multi-manager approach hold up, as opposed to a pure multi-asset-class fund?

FATIMA VAWDA: Well, first of all, thank you very much, Ryk, for having me on your show. In fact, I think it’s been a really good opportunity for multi-manager portfolios and fund-of-funds portfolios to shine, relative to single-managed portfolios, largely because of the volatility in the markets, as well as, when it comes to risky assets, the different styles that allow you to achieve the diversification benefits. And it’s really been a stout player in the market.

So, while we’ve had significant upside come through the market because of the central bank interventions, and because of the fiscal and monetary policy stimulus, globally and domestically, the jump in the market has not been widespread. If you look at what’s happened globally, it’s largely been the funds that have performed, and global quality has performed. So, if you were a single manager and your style was out of favour during this period, it could be detrimental to your performance.

And so the benefit of a multi-manager portfolio is that, particularly within the asset classes that drive investment returns, we have the ability to bias our portfolios towards a style of factors that we believe are going to have a high probability of delivering value in such a volatile period.

So, for example, if you’re a value manager over this period coming into 2020, you perhaps were a lot more positive that you could see some of that unlock come through, even within the mid-cap and the small-cap space. But, unfortunately, Covid-19 has delayed that, and those catalysts to see that unlock of value are going to take a long time.

And so, as a multi-manager, we have the benefit to say, well, okay, we think that value’s not going to do well over the next period, or we let’s hedge our bets and we’ll have a little bit of value in the portfolio, but overall we can optimise our style blend in a way that can favour the current market conditions.

Predictions for various asset classes

RYK VAN NIEKERK: Of course, it’s critical for a multi-manager to get the asset allocation right. Can you quickly go through the asset classes and give us your insights into how you think they will perform, say, in the short and medium term?

FATIMA VAWDA: We run multi-asset class portfolios and, typically in South Africa those multi-asset class portfolios are limited in terms of Regulation 28 of the Pension Funds Act, because they’re really focused on gathering compulsory assets and therefore there are prescriptive limitations there.

The retail portfolios that are packaged within unit trusts are slightly different to our institutional portfolios, because the current Collective Investment Schemes [Control] Act [Cisca] prohibits you from adding unlisted exposure, which I think is something that will perhaps change going forward. So, in our institutional portfolios, we do include asset classes that have the ability to immunise and hedge long-term liabilities. And, therefore, increasingly we’re looking at the unlisted space to be able to achieve that. One, because returns are higher, and, two, because they have the ability to also create some form of impact on the South African economy.

So if we look at our typical multi-asset class portfolios on the retail side, we’d have domestic equities, domestic bonds, inflation-linked bonds, cash, a little bit of listed property.

And then of course we maximise our offshore allocation, and that’s largely been in the developed-market space.

Because there’s an emerging economy we see an additional risk premium based on potential returns. And therefore we wouldn’t want to pick aggressive exposure to other emerging markets when 70% of our portfolio is already in an emerging market.

So the retail portfolios – we’ve got the standard vanilla asset classes, which is global equities. Like I said, we are more focused on developed markets, domestic equities. We really staying away from the mid-caps, the small caps; we are staying away from value. We’ve got a tactical style tilted towards quality growth size, the large caps.

And then of course the bond market. We have to be in the bond market, firstly because of the prescriptive limits. But the other reason is:

…regardless of what the fiscal situation looks like at the moment, our bonds are still really attractive for international investors.

And it really depends on which part of the yield curve you play.

So diversification from an asset-class perspective, and the way we achieve our diversification from an asset-class perspective, is working backwards, understanding what our investment objective is in a multi-asset-class portfolio, and then really applying both the quantitative and qualitative process to achieve that optimal asset allocation.

On the quantitative side I think we run over 200 000 simulations to achieve that optimisation. And then, of course, on the qualitative side, understanding the drivers of return and ensuring that we are positioned.

So we have our long-term strategic asset allocation. And then, over the short- and medium term, we’ll tactically underweight or overweight relative to that long-term asset allocation.

RYK VAN NIEKERK: You said earlier that you see the unlisted investments as a separate asset class. Can you maybe just elaborate on what the approach is? Is it a private-equity type of investment?

FATIMA VAWDA: We have private equity in our institutional portfolios. I think the JSE has really shrunk over the past decade. A decade ago we had about 650 shares listed on the JSE; currently we have about 330 shares listed on the JSE. Also the concentration on the JSE, largely, if we think about the meteoric rise of Naspers and now Prosus has really resulted in a local bourse that is carried by a non-South African-focused business. And outside of the large-cap rand-hedge counters, there’s very little opportunity on the JSE.

So, given that the JSE is shrinking, and we’re seeing the rise of institutional investors investing in unlisted markets like private equity, and because private equity comprises long-term investments and has annualised historically in excess of 20%, we think that for institutional portfolios it’s a good addition to the portfolio.

And, if you think about the blended-finance opportunities that are coming to market, specifically because I think a compromise for government, not going the prescribed-assets route, is to provide a bit of a sweetener to attract retirement-fund capital in private market investment, to invest alongside government in strategic investment projects, which can generate significant upside for patient investors who can put away long-term capital.

So yes, we do have exposure to unlisted investments in our institutional portfolios. They have added value so far, and we think that they’ll continue to add value, largely because of the structural impediments of our listed markets.

Prescribed assets

RYK VAN NIEKERK: What are your views on the probability of prescribed assets, or a change in the Regulation 28 provisions?

FATIMA VAWDA: I think the change is coming. I think our Minister of Finance, Tito Mboweni, flirted with the idea and kind of said something when he announced the new budget a couple of weeks ago. Cisca has made a submission to the National Treasury, requesting that the alternatives bucket a bit – currently split between hedge funds and private equity – be divided because those two are very different types of investment, and they are bucketed together in the alternative space. I think there are submissions that have also been made to the fiscus to amend Cisca regulations to allow for unlisted investments.

So, I think, one, that regulations will be changed to allow for direct exposure to unlisted investments, both in the institutional space and in the retail market. And, two, I think it’s a compromise from government to say: “Well, we won’t have traditional prescribed assets in the way the apartheid government had implemented prescribed assets, but we will rather do that in the form of public-private partnership and blended-finance opportunities, where you create a win-win situation for investors, while at the same time you achieve economic development growth in the potential for job creation.”

RYK VAN NIEKERK: There’s a lot of opposition to being forced to do things in South Africa, especially with the high levels of distrust currently. But it seems you are slightly positive about the prospects of funds to actually achieve above-average earnings from such investments.

FATIMA VAWDA: I’m opposed to the traditional form of prescribed assets, which is the way the apartheid government implemented it. I am supportive of public-private partnerships and blended-finance opportunities, because I do think that, from a source of return perspective in South Africa, we are limited. The JSE is not giving us that source of return. I mean, if you look at over a 60-month period, over a five-year period, we’ve annualised less than 5% of the JSE, and I think investors are frustrated. We need to generate above-inflation returns. This does provide us with an opportunity to look at different ways of achieving impact in our economy, while at the same time achieving good investment returns

RYK VAN NIEKERK: But can that not be achieved without prescribed assets?

FATIMA VAWDA: One hundred percent, it can’t. But what is attractive to crowd in private sector capital is a sweetener that government provides. I’ll give you an example. We recently were awarded a mandate from the National Treasury’s Jobs Fund and, as a sweetener to attract third-party capital-matched funders, government comes in as the first loss tranche in the overall private-equity mandate. And it also provides an enhancement to the matched funders on the investment return. It stand out to be a phenomenally attractive investment. And we’ve raised the matched funding against the grant funding that we received from the National Treasury’s Jobs Fund. It’s worked very successfully in the OECD regions. It’s worked very successfully as part of the National Treasury’s jobs fund over the past decade. And I do think, if you do it very cleverly and innovatively, you are going to attract matched funding and you are going to achieve objectives. We’re not saying that we’re going to go into investments that that are potentially risky. Everything needs to go through the normal processes of due diligence and ensuring that everything is up to scratch.

Changes to investment approach, adopting AI

RYK VAN NIEKERK: Interesting. Let’s talk about markets again. The world changed in March, especially in South Africa, and then internationally we saw a massive crash in March. We saw a rebound in April. Markets continued to rise steadily and many markets, including the local market, actually hit record highs for the year quite recently – and many people are scratching their heads. How are you looking at this? And have you changed your investment approach?

FATIMA VAWDA: Yes, we’ve made a significant amount of changes in our multi-asset-classes fund. Yes, we’ve had a fantastic three months that have largely been driven by fiscal and monetary stimulus. One could argue that there’s a dislocation between Main Street and Wall Street, but a lot of it has not been globally. If we see what happened in international markets, as I said earlier, the biggest run has been in the Faangs [Facebook, Amazon, Apple, Netflix, Google]. It’s been in quality type of stocks. We’ve seen IT run quite aggressively. We’ve seen healthcare counters run quite aggressively.

But then you see the losers, the losers with the likes of the financials internationally. And, if you look at the domestic market over the last while, the biggest movements and the positive movements came from the gold miners because of the risk-off sentiment and the gold price rallying so aggressively.

And then we also saw a big movement in the tech counters, with South African Inc type of counters not doing well, particularly consumer-facing retail businesses as well as financial counters.

If we look into all of that, and we sit back and we say, okay, well, we are a multi-manager.

We don’t think that there’s an opportunity in the mid-cap space. We don’t see opportunity in value. We don’t see opportunity in small caps.

Over the past five years only 20% of active asset managers have outperformed their benchmarks. We’ve seen the dominance of growth relative to value. We’ve seen the erosion of any type of small-cap and mid-cap sized premium. And we’ve really seen this flight to balance-sheet quality over profitability, with a lot of counties restructuring their balance sheets, and so forth.

So, over the past two years, what we’ve been doing at 27four is we’ve been hiring a lot of data scientists, and we’ve been increasingly moving towards using machine learning. Another word to kind of talk about it is more artificial intelligence (AI) in the way we pick asset managers.

So, if we think back that over the past five years less than 20% of active managers actually outperformed their benchmark, one could just say: “Well, why don’t you just go for passive? What about actually digging deeper and finding those 20% of managers that do actually outperform their benchmark, and are they identifiable?”

Globally the move to big data, machine learning, artificial intelligence, is increasingly being applied in the asset-management space.

And so what we did was we ran our models over 600 general-equity funds in South Africa, and we’ve been able to bridge that gap between what we believe is pure, rules-based investing and active management, and we’ve gone to the market and we’ve looked at new managers. We are overhauling our domestic equity, a bull ring block. We’ve selected four managers that are coming into our portfolios whom we believe from a style analysis and blending – from manager skills, from a risk premium perspective, from a sector and style diversification perspective – and we think that they’re going to add value to the portfolio.

RYK VAN NIEKERK: Is it working, the AI approach? There’s a lot of research going into it, but have you outperformed your benchmarks over the last two years since you implemented this model?

FATIMA VAWDA: We started bringing in a lot of data scientists and doing research over the past two years, and we’ve finally got to the point now where we’ve just recently implemented those changes in the last couple of weeks. So it’s an exciting time to speak to you because, when we came into 2020, our views on the markets were very, very different. As I said to you, perhaps we could have seen the unlock come through from our holdings that we held in the portfolio. So what we have decided to do, following this analysis and review of the equity-building block, we have terminated three of the managers in our equity-building block on the domestic side, and we’ve introduced three new managers on the domestic side. We believe that there’s a 70% probability of these guys looking forward to outperform their respective benchmarks.

New equity-building block managers

RYK VAN NIEKERK: Who did you fire and who did you appoint?

FATIMA VAWDA: It’s unfortunate but, given the current market cycle we don’t expect to see unlock coming from the value side. And so unfortunately Denker was one of the casualties. We don’t see rising interest rates any time soon; this market is going to commodity prices, which are going to remain strong. We don’t see economic growth coming through any time soon. The environment just doesn’t suit that kind of strategy. If things change in the future, we’d always look at them again. So unfortunately Denker was a casualty and similarly … a casualty in the portfolio. They’ve been very good managers who have been with us for very, very long time, but unfortunately the current cycle of the market is not suitable to them.

RYK VAN NIEKERK: The third one?

FATIMA VAWDA: The third one – we haven’t yet nominated something, so we keep it quiet.

We’re doing the same recipe on the global side as well. Across our institutional portfolios and the domestic portfolios we’ve brought on the likes of Fairtree. We think that Fairtree has got a process that is adaptable to the new environment. We like what they’re doing and you know, we are confident of their ability to deliver. Stephen Brown and Cor Booysen currently manage around R69 billion as a house. The other manager we brought on of course, whom everyone’s fairly familiar with, is the likes of Investec Asset Management and Ninety One portfolio, managed by Hannes van den Berg and Unathi Loos. And they use a combination of quantitative stock screening and bottom-up fundamental research.

And then a nice outsider that we’ve brought in is the likes of a small manager called Rensko. We believe that it has very specific strengths in specific areas. And, when we put them together with the other managers in the portfolio, the likes of Coronation and some of our passive exposure, they work quite well.

And then of course, one of the other niche boutique managers that has been around for a long time, and we think that it’s well positioned to deliver results going forward, is the likes 36One. So those are the four managers that we’re bringing on in various different weightings, depending on the multi-asset-class portfolio.

And we’ve really taken the positioning of bringing in quite a bit of passive in all of our portfolios – so on the fixed-income side, and on the equity side as well. On the equity side we’ve gone for the Top 40. We think that the Top 40 has got a natural growth and momentum tote. It has exposure to all the rand-hedge counters.

And then we do have our beta exposure to the overall general equity market through SVIX. So lots of changes on the domestic equity side.

We’ve brought in a little bit of passive to complement our exposure on the fixed-income side. And then we’re running a similar process on the global side.

So we’re hoping that these changes that we’ve made position the portfolios better, and provide that buffer [against] aggressive downside moves but are able to generate decent upside going forward.

RYK VAN NIEKERK: We will most definitely speak next year to see how successful this approach is. Very interesting, indeed, Fatima. Thank you so much for joining me and really good luck. These are not easy times to be an investment manager.

FATIMA VAWDA: I appreciate that. We’re seeing a lot of opportunity and I see the positive in any kind of stressful moments. So we’re looking forward to it and happy to chat again next time. Thank you so much. Take care.

AUTHOR PROFILE

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What is going on at 27four…They have lost 2 CIO’s in the last 6 months…

I saw red flags at ‘multi asset class portfolios’ and just saw give me your money

What’s the issue with ‘multi-asset class portfolios’? It is a standard term in the industry.

Yes. So are ‘Credit-linked synthetic collateralized debt obligations’.

Financial industry needs to get wiped back into shape.

Africa Pragmatist
So what’s the issue with ‘multi-asset class portfolios’?

Multi-asset is a great concept. Asset allocate to exploit various risk premia (credit, equity, insurance-linked and so on).

Multi-manager works great if one has the skill to 1) Asset allocate and 2) find the best fund to use as building blocks. Both are essential in managing multi-asset class portfolios.

This group has a track record of neither!

MrPule
You have a nice theoretical understanding of multimanager but investment theory and practice are different. In theory, you could also be a good multimanager but let’s see you try and methinks you’ll be carried out on a stretcher. Only then will you have a better perspective on multimanager performance. The game is easy from the sidelines.

The real question is whether you believe a high paid CIO or a machine learning algorithm is better at picking and blending funds. My money is on the future

Lots of buzz words to increase margins – unlisted, AI, impact. Challenge is one has to be good/experienced to be entitled to higher fees.

Take multi-manager – buzz word of the 90’s by the infamous Investment Solutions, M-Cubed etc. Lets dampen the portfolio risk (as defined by volatility) by investing across a number of managers – end up with the market index or a portfolio with some sort of market bias or tilt (growth, value etc.). It worked as it gave a false sense of diversification.

This does not bode too well in the unlisted space, where there is significant dispersion of returns, and risk is seen as the permanent impairment of capital.

I have had a detailed look at past performance (refer to https://www.27four.com/fund-centre/#retail201710) and the results are not very convincing.

Why move into new investment areas when the foundations of the business are still shaky/settling?

Mama bird above needs to eat! Hence new words and products and to keep the clients invested

Watch that gunt. Especially with the covid pandemic around.

Changing tact because the stock market has shrunk. Wow.

These guys are dangerous. Establish expertise in private equity before going cap-in-hand. Do they have an understanding of sourcing, operational expertise and managing underlying private businesses?

Board governance and accounting valuation skills are simply not enough.

Changing tack, tact refers to sensitivity when dealing with difficult issues, changing tack comes from the nautical term for changing sails when the wind direction has changed, sorry for being pedantic!

Multi-managers and fund of funds work with lay investors. Its gives a sense of comfort. In reality, lets appoint 5 fund managers, all of whom trade the same underlying universe of securities. In behavioral finance this phenomenon is known as “regret avoidance”.

One could get away with this in vanilla asset classes. However, for unlisted investments, high frequency trading and other exotic asset classes, one can get severely shagged when multi-managing or “blending” other people’s funds together.

End of comments.

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