Fund Focus: PPS Equity Fund

Studies show that most active asset managers end up underperforming the market over time. In South Africa, the job is potentially even more challenging because of the construct of the Johannesburg Stock Exchange (JSE).

Firstly, the local equity market is relatively narrow, with the universe of investable shares having become considerably smaller over the years. Twenty years ago, there were over 600 companies listed on the JSE, but that number now stands at less than 300. Secondly, concentration poses another challenge, with the 50 largest JSE-listed stocks making up around 85% of its total market capitalisation. The investable universe is therefore relatively small, and the choices are limited.

Just like the structure of the JSE has changed over time, our approach to combining managers in creating a high-quality solution, like the PPS Equity Fund, has also evolved over the years, resulting in the fund outperforming its benchmark (FTSE/JSE Capped SWIX) over 3, 5 and 7 years, also ranking favourably on a peer-relative basis over these respective periods.

Manager selection is key

As a multi-manager, our enhanced industry-leading asset manager research process gives us a distinct edge to focus our attention on finding exceptional managers with complementary strengths that meet our strict internal criteria. The domestic-only equity solution, PPS Equity Fund, is constructed from this distilled universe of asset managers, against the backdrop of the difficulties posed by the idiosyncratic SA equity market. The PPS Equity Fund is made up of a combination of active SA equity managers, each managing a segregated mandate wherein they implement their best SA equity investment view, while staying fully invested in SA equities. The manager combination is deliberate and seeks to overcome the challenges posed by the structure of the local market, with the goal of delivering more consistent returns relative to its FTSE/JSE Capped SWIX benchmark over time.

Elements of portfolio construction

From a portfolio construction perspective, we feel that that there are three important elements that need to be reflected in a fund like the PPS Equity Fund for it to succeed.

Firstly, because of the size of the SA market, we have developed a natural bias toward style-agnostic managers over highly style-biased managers, who face an even smaller investable universe and a high degree of cyclicality.

Secondly, we find that an element of benchmark awareness is useful in further improving the portfolio’s overall “hit-rate” of outperformance over rolling periods, combined with proven benchmark agnostic alpha generators.

And finally, in terms of capitalising on the opportunity set locally, our view is that managers who have both top-down and bottom-up strengths have an advantage in the SA market, which tends to be disproportionately driven by macro forces.

It is worth emphasising that highly style-biased managers are by no means less compelling in absolute terms, and that the lower tracking error characteristic, often associated with more benchmark aware managers, is by no means more desirable. The “Buy List” that we use includes managers of all types, which is implemented across the PPS portfolios. When it comes to the PPS Equity Fund specifically, we seek a specific combination of features that leads us to focus on managers with fewer constraints (e.g. style or size), and with a higher hit-rate of being able to capture more of the upside when the market is rising relative to downside participation.

Speaking to manager selection, the PPS Equity Fund is equally invested across three managers: Ninety One, Fairtree Asset Management and Truffle Asset Management.

• Ninety One combines both bottom-up and top-down elements in their process, which focuses on investing in reasonably valued shares where expectations of future profits are being revised upwards. For them, analyst earnings “upgrades” are a critical factor in share price trajectory. To get a more consistent return profile, the manager blends valuation (a longer-term, mean reverting fundamental factor) with earnings revisions (a shorter term, trending, or behavioural factor). This allows the manager, at times, to have a momentum component to its portfolio. The manager is, however, willing to shift the portfolio fairly aggressively as circumstances change.
• Fairtree Asset Management also utilises both bottom-up fundamental equity analysis, as well as top-down macroeconomic analysis, to construct a portfolio with a positive bias to reasonably priced leading companies in industries that are benefitting from prevailing economic conditions and a negative bias to companies that participate in industries that are adversely affected. Fairtree’s ability to decisively reallocate capital to companies that benefit from changing economic conditions, has allowed them to perform through the cycle by moving between value and growth styles, as and when it becomes appropriate.
• Truffle Asset Management is a valuation-based manager that constructs somewhat benchmark cognisant portfolios and benefits from a clear understanding of the macroeconomy and its effect on companies when positioning the portfolio. Although Truffle follows a valuation-based approach, they are unique in their ability to dial this either up or down as is appropriate. They are also willing to consider momentum in their stock selection decisions when necessary. Their overarching view is that the intrinsic value of a company is a function of the companies’ normalised earnings, and they are willing to trade around intrinsic value for incremental gains. The manager seeks independent sources of return in the portfolio to improve diversification by not relying on one economic or company outcome.

Together these three managers combine well to incorporate all the elements which we consider important for a market-beating multi-managed solution. There is an appropriate balance of diversification and aggression, which is critical in creating a solution that is competitive and adds value.

Performance has been particularly strong since the equity market sell-off in early 2020, with Fairtree having been a key contributor.

Looking ahead, we are excited about the continued strong prospects for the PPS Equity Fund given the calibre of its underlying managers, as well as the prospects for the asset class, thanks to attractive starting valuations in SA.