What it takes to outperform during periods of extreme uncertainty

To outperform the market in recent years, investors have had to hone their risk management and hedging strategies, increase their focus on asset allocation, and proactively seek out pockets of opportunity.

This approach should continue to yield benefits for the foreseeable future as global economic growth remains weak, according to GraySwan CIO Gregoire Theron.

While it was previously relatively easy to generate healthy returns in a bull market that delivered broad-based gains, the macroeconomic landscape has become far more complicated. Financial markets have been exceptionally volatile since 2020 due to a wave of shocks, including the Covid-19 pandemic, supply chain disruptions, and Russia’s war on Ukraine. Growth assets in general have been hit particularly hard. “The old playbook no longer applies,” Theron says. “Generating alpha now requires a much more proactive and nimble approach, with a strong focus on strategic and tactical asset allocation, hedging strategies, and a willingness to act as and when opportunities arise.”

There is plenty of evidence to support this assertion. Since the onset of the pandemic, funds that have become more active in terms of asset allocation have generally outperformed. For example, in the three years to end-May 2023, the GraySwan Moderate fund of funds delivered annualised returns of 14.02% – well ahead of the benchmark’s 10.15% performance.*

This was thanks to the hands-on investment strategy adopted in the early days of Covid-19. The sharp increase in volatility, which was initially sparked by lockdowns, has required an increased focus on risk management, and on seeking out funds and assets that are well placed to outperform.

“While growth could be found in almost any asset class and geography prior to the pandemic, that’s no longer the case. But that’s not to say that opportunities don’t exist,” Theron says. South African bonds and equities, emerging market equities, global property as well as commodities, are currently attractively priced, for instance.

Nevertheless, caution is needed, particularly in the South African market, where multiple crises are weighing on the domestic economy. There remains no end in sight to the crippling power crisis, while critical infrastructure and key state-owned entities continue to deteriorate. The risk of social unrest also remains elevated, with unemployment and inequality at unacceptably high levels.

With the change in the offshore allowance as per Regulation 28, Grayswan acted swiftly and reduced its local equity, fixed interest and listed property exposure, and redeployed that capital into the offshore markets with specific focus on other emerging markets, such as Brazil, China, India, and Taiwan. Those markets offer more stability on a relative basis, and valuations compared to developed markets are exceptionally attractive. Although local funds are restricted from making substantial shifts into offshore assets, these allowances should be maximised at the current time, Theron says.

GraySwan has also trimmed its overall equities allocations and added to its cash and income holdings, where yields have climbed significantly. Aside from boosting income generation, this has helped to mitigate risk and volatility in the uncertain economic environment. As of end-May 2023, fixed income assets account for nearly 50% of the GraySwan Moderate fund of funds. “It’s also important to pick your battles,” Theron says. “While there are still opportunities in South Africa, as some segments of the stock market are overlooked or not appropriately prices, it is much more difficult to find alpha in highly efficient developed equity markets, which is why we opt for higher passive allocations outside of South Africa, specifically in developed markets.” This has the added benefit of keeping trading fees and overall costs in check – another important contributor to outperformance.

The GraySwan Moderate fund of funds has a total expense ratio of 1.26%, which is well below the industry mean of 1.54%. Since it was launched in July 2017, the fund has returned an annualised 7.96%, versus 6.82% for the benchmark.* “We will stick to our proven investment strategy for the foreseeable future as the world continues to navigate a turbulent period,” Theron says. “Inflation remains stubbornly high, while several advanced economies face the prospect of a looming recession, and high interest rates take their toll on growth assets.”

“This means we will maintain our mostly risk-off approach, while also looking for opportunities to increase risk at the right time.”