The intricacies of asset allocation
Recent amendments to regulation 28 of the Pension Funds Act make it possible for asset managers to invest as much as 45% of affected funds offshore; but the decision to do so is far from simple. Nothing illustrates the challenge these managers face, nor the complex interlinking of the financial advice and financial product universes, than spending some quality time with a leading financial services provider.
Sticking with one’s knitting
The two-day-long 2022 Glacier Life Investments Summit, which was held virtually towards the end of March this year, boasted a packed programme dedicated to “the intricacies of the intermediary value proposition”. This writer was soon immersed in topics as diverse as bonds, endowments, fixed income solutions and tax, to name a few.
The best approach in situations such as these is to stick with what you know best, so we immediately skipped past the endowment- and tax-focused content to the series of presentations dealing with the Glacier Solution Funds, and more specifically the single slideshow dedicated to high equity balanced funds. For the uninitiated, solution funds are a range of actively-managed funds that are constructed to match specific investor risk profiles, thus simplifying the fund selection process for both financial adviser and client. Thus follows a summary of the asset allocation wisdom shared by Brian Thomas, Co-Portfolio Manager on the Amplify SCI* Balanced Fund: a R40 billion multi-asset fund that is managed on behalf of Amplify by Laurium Capital.
“We tend to run reasonably high [levels of] equity, even within the high equity category, with our focus being on beating inflation, delivering long term capital growth and protecting [investors] from market downside,” said Thomas. “We actively manage both equity and fixed income positions within the fund”. The fund’s asset management team is tasked with making ongoing tactical asset allocation decisions which involve identifying the best risk-adjusted returns on offer from the available asset classes and combining those opportunities to generate optimal outcomes for investors. The resulting high equity skew is supported by global stock market statistics, going back decades.
120-years of equity outperformance
Long-term data from the US confirms that equities offer the best real returns over time. “Going back 120-years, US equities have consistently beaten the return offered by fixed income on an inflation-adjusted basis,” commented Thomas. The JSE achieves similar, with SA equities beating bonds hands down over time. According to Thomas, there is no reason for investors to expect different return outcome from this asset class over the next century: the history books confirm the return reward premium that attaches to taking extra equity risk over! “This makes us firm believers in running a reasonably high equity fund in the balanced fund space, and we are generally pretty close to the 75% equity maximum allowed under regulation 28,” he said.
If only generating market-beating returns was as simple as maximising a fund’s equity exposure. For Laurium, the asset allocation journey begins with assessing the return expectations for each asset class given the overarching macroeconomic view. The challenge then becomes building a portfolio of local and offshore bonds, cash, equities and property that is appropriate given this view and the prevailing investment themes. At the end of Q1 2022 the Amplify SCI* Balanced Fund was overweight SA Equity and SA Bonds and underweight Offshore Equity and Offshore Bonds, while SA Property still out of favour. The allocation to the latter remained well below the fund’s base investment case. Choosing the individual companies to make up the local and offshore equity part of a portfolio is a tougher ask. Each share is picked following a rigorous screening process that includes looking at traditional ratios and conducting a deep fundamental analysis of potential investments.
The fund has not, however, shied away from achieving diversified equity exposure using index exposure, listing the iShares Russel 100 Value (6.9% of the portfolio) and the S&P 500 ETF (2.3%) among its top 15 positions. Locally the focus is on the financial, healthcare and resources sectors. “Banks and insurers have had a very good year thus far, and we are actively switching between these sectors as-and-when we see value in the market,” said Thomas, before commenting on the high cash yields on offer from selected resources shares.
Making hay from mining and resources shares
The fund has significant exposure to the resources sector through diversified miners and the likes of Sappi and Sasol. “The diversified miners have been big sources of return and we believe they will continue to be; they are on incredibly high cash flow yields at the moment and offer significant upside to fair value at current commodity prices,” Thomas said. Another differential component in the fund’s equity portfolio comes through its increased holding in Mediclinic, which offers upside as it reprices following the Covid-19 pandemic.
A graph of the fund’s asset allocation mix since its inception in December 2015 confirms an active asset allocation approach over time. According to Thomas, asset class exposures are adjusted relative to the fund’s strategic asset allocation or base case, at all times seeking the best risk-adjusted return. This approach has contributed to the fund achieving a net annualised return of 9% over its life. “We are proud of the track record that we have poduced in this fund,” he said. To repeat this return in 2022 requires positioning for a low growth world, with global GDP growth pegged at around 3.5% this year, and SA struggling to achieve 2%.
As for other economic indicators, Laurium expects SA interest rates to increase to 8.25% this year, with fair value for the rand against the US dollar at around R16 to the dollar and oil at an average US$75/barrel. Against this backdrop, the fund is invested at 49.2% in SA equity; 16.6% in SA bonds; 3.8% in Africa; 2.7% in SA property; 4.4% in offshore bonds; and 19.9% in offshore equity. “We have made some slight changes to our base case given the larger regulation 28 allowance offshore; we are also reasonably overweight in SA equity because we still see value in the local equity market on a on a relative basis,” said Thomas.
US equities remain expensive
Offshore equities are not as promising, and the fund enters the second quarter of 2022 underweight this class relative to its baseline due to concerns over expensive valuations. The mix of overweight SA bonds and underweight offshore bonds was echoed by the asset allocations of many other local multi-asset funds at the time.
Writer’s thoughts:
An investor faced with hundreds of fixed income or balanced funds could be forgiven for yearning for simpler times, with fewer products to blur their decision making. The good news is that there are dozens of expertly-managed funds across multiple unit trust categories, making the chance of selectin a top quartile performer much higher. Do you have a preferred balanced fund? And is your choice more influenced by brand loyalty or fund performance? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.
