What makes a good fund manager?

Rob Dower, chief operating officer at Allan Gray.

Whether an investment is actively or passively managed can be a distraction from whether it is well-managed.

Look past the labels

The best portfolio for most long-term investors is some kind of balanced fund, with a level of risk most appropriate for their needs and temperament. There is no generic index that provides this; someone has to decide what percentage to invest in equities, bonds, cash and property and how much to place offshore. For the equities, someone needs to pick the individual shares, or to decide which index to follow.

Someone decides the cap for individual investments (for example, including Naspers at its current index weight of more than 20% is a bold bet). For the offshore portion, which offshore investments are included makes a difference- there are many credible options, including index-based ones. Even if all of these choices are made mechanically (“passively”), they are real choices and they make a big difference to the outcome for an investor. “Passive” is often used as a marketing label to signal low fees. Astute investors will look past a label to rigorously compare costs between products, and consider them relative to long-term returns and to the quality of the service they receive.

Consider the companies, not the index

Rightly, in the past year, there has been an increase in public pressure on fund managers like us to actively exercise clients’ ownership responsibilities, holding the managers of companies to account for their ethics and their performance, rather than taking a short-term view and simply selling a share. Surprisingly, some of this pressure has come from passive managers, who are by definition long-term owners of the shares they hold, yet are seldom seen asking questions in shareholder meetings. This is an opportunity missed. Passive funds own every share in the index and, like their active counterparts, have a fiduciary interest in the success of these companies.

In any event, when it comes to individual stocks, the FTSE/JSE All Share Index (ALSI) is a poor starting point for a portfolio. It is better to consider each share investment on its own merits. The companies listed on the JSE have not been assembled to give investors in South Africa a good spread of the different global sectors, or even of SouthAfrica’s economy - they are a random group of large and small companies with a connection to South Africa.

Worse, their weights in the index are a function of their size (a few big international companies dominate), their point in a business cycle, or short-term swings in their share price, not their long-term attractiveness to investors.As just one example, in mid-2008, Anglo American was more than 17% of the index. By early 2016 its share price had fallen by 90% from its peak. This is a sobering nine times bigger percentage point loss to the index than Steinhoff’s decline has caused.

The best managers are not hard to find in South Africa

Rather than starting with an index, it may be prudent to find an investment manager that you trust to invest your hard-earned savings. To us, it is all about careful stock picking. We invest our clients’ savings in shares that are trading for less than our estimate of their worth to a long-term investor. Sometimes this means we find value where others fear to tread. Positive sentiment drives prices up; we prefer to buy when things are on sale and we are convinced the price does not reflect the true value. During 2017, we upped our exposure to local equities, which surprised some investors given the mood of uncertainty at the time.

Sentiment has turned and while it may well be the beginning of a period of growth and prosperity for South Africa, diversification is still important. Our stock market is concentrated with a lot of weight in a few shares, but it is also narrow, making up only 1% of the world’s share investment universe. If you live here, it makes sense to diversify your savings and allow some of your money to earn returns elsewhere, not because the rest of the world is any less risky - the outcomes here are as unpredictable as they are in any other country, and our political stresses are not materially worse than those in Brazil, Turkey or Russia, for example - but because the bad things that could happen elsewhere are unlikely to be correlated with bad things happening here. In addition, investing outside South Africa gives you a much larger universe of shares to choose from. Of course, the message to choose carefully holds just as true for global markets, which are currently looking very overvalued overall - the FTSE World Index was up 24% in US$ in 2017.

Do your homework

In an ever-changing landscape, look for a manager who has a proven long-term track record of delivering returns and living up to their promises and who follows a consistent investment philosophy through the cycles.