Tem­per your ex­pec­ta­tions

Finweek English Edition - - ALLAN GRAY -

South Africa has been a great place to in­vest in over the past 15 years, with all as­set classes de­liv­er­ing re­turns well above inf la­tion. This has pro­vided a boost for low eq­uity strate­gies. Ma­hesh Cooper, a direc­tor at Al­lan Gray, ex­plains that very long-term his­tor­i­cal data and cur­rent high as­set val­u­a­tions sug­gest that in­vestors should pre­pare them­selves for lower real re­turns go­ing for­ward.

Al­lan Gray has been con­cerned about the level of the South African eq­uity mar­ket for some time. “His­tory sug­gests that at some point the pen­du­lum must swing back the other way. From the cur­rent high start­ing point, we ex­pect that the next 15 years are likely to be far more chal­leng­ing,” says Cooper. Us­ing data com­piled over the past 115 years, Al­lan Gray looked at the af­ter­inf la­tion re­turns of dif­fer­ent South African as­set classes. It used this data to con­struct the­o­ret­i­cal re­turns over rolling 10-year pe­ri­ods for a low eq­uity port­fo­lio in­vested in South African as­set classes, com­pris­ing one-third eq­ui­ties, one-third bonds and one-third cash. The re­sults are dis­played in the graph.

The solid blue line in the graph be­low shows the re­turns this port­fo­lio has pro­duced, with the bars rep­re­sent­ing the con­tri­bu­tions from the dif­fer­ent as­set classes, while the dot­ted black line shows the av­er­age of th­ese 10-year real rolling re­turns – just over 3% per year above in­fla­tion.

Look­ing at re­cent his­tory, one can see how re­turns from all South African as­set classes have been well above their long-term av­er­ages. How­ever, there have also been pe­ri­ods when this low-eq­uity port­fo­lio has de­liv­ered re­turns be­low in­fla­tion over a 10-year pe­riod, some­times for long pe­ri­ods at a time.

“Af­ter a long pe­riod of re­turns well above av­er­age [since the early 1990s], re­turns could be be­low their long-term av­er­age for a pe­riod of time,” Cooper cau­tions. With this in mind, Cooper looks at the po­si­tion­ing of the Al­lan Gray Sta­ble Fund, a fund ded­i­cated to de­liv­er­ing above-cash re­turns with a low risk of cap­i­tal loss.

“When we launched the Sta­ble Fund 15 years ago, we hoped that it would pro­vide clients with re­turns that were su­pe­rior to bank de­posits. The fund has more than lived up to this, ex­ceed­ing bank de­posits by 5.8% per year since in­cep­tion,” says Cooper, adding that it is im­por­tant

DIREC­TOR, AL­LAN GRAY to re­mem­ber that this per­for­mance is in the past, and that prices to­day de­ter­mine re­turns go­ing for­ward.

Al­lan Gray fol­lows a val­u­a­tion-based in­vest­ment phi­los­o­phy and con­structs port­fo­lios from the bot­tom up, look­ing for as­sets, such as shares, bonds and prop­erty, where the cur­rent price is lower than its es­ti­mate of their in­trin­sic or un­der­ly­ing value. The Sta­ble Fund’s port­fo­lio man­agers start with the ob­jec­tive of pre­serv­ing clients’ cap­i­tal and then seek to de­liver re­turns in ex­cess of cash. The fund’s po­si­tion­ing is a di­rect re­sult of this: shares and other as­sets are se­lected based on their at­trac­tive­ness rel­a­tive to cash.

Look­ing at cur­rent val­u­a­tions, it should not come as a sur­prise that the Sta­ble Fund is cau­tiously po­si­tioned at the mo­ment, and this cau­tious po­si­tion­ing has hurt rel­a­tive re­turns. Cooper ex­plains that, as is the case with all Al­lan Gray funds, the port­fo­lio man­agers pay no at­ten­tion to how the fund’s com­peti­tors are in­vested or the com­po­si­tion of any bench­mark, but rather make sure that the fund is po­si­tioned to pro­vide down­side pro­tec­tion if val­u­a­tions re­turn to more nor­mal lev­els.

“In light of cur­rent mar­ket con­di­tions, we be­lieve that the fund is ap­pro­pri­ately po­si­tioned to de­liver on its ob­jec­tives and to pre­serve and grow our clients’ in­vest­ments over the long term,” concludes Cooper.

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