Fine-tune portfolio diversification with the family tree of investing
FOR once, share prices and economic data dropped off the businesslunch circuit this week. Talk, instead, focused on DSK — Dominique Strauss-Kahn — the 62-yearold Frenchman whose spectacular fall is matched only by the salacious tale which caused it.
For those who’ve been in the bushveld, DSK spent most of the past week in New York’s Rikers Island prison. He stands accused of forcing himself on a hotel chambermaid young enough to be his fifth daughter. Bail was granted on Thursday, at the second attempt, with conditions consistent with those imposed on serial sex offenders.
Until last week, DSK was best known as managing director of the International Monetary Fund, the body which monitors the world’s economic risks, and those of its 187 member countries. Within a month he was expected to announce his candidature for the French presidential election, where he was likely to defeat the unpopular Nicolas Sarkozy.
DSK’s accuser is a 32-year-old single mother who says she thought the $3 000 a night suite at the New York Sofitel had been vacated. She says that she started cleaning when the naked grandfather pounced on her from the bathroom. Adding to the tabloid drama are reports that later that afternoon, United States police hoisted DSK out of his first-class Air France seat only minutes before its takeoff for Paris.
Conspiracy theories have been quick to surface. London’s Telegraph newspaper reported that news of the scandal first appeared on a right-wing blog (DSK is a socialist), suggesting that there is more to this than a poor immigrant from Guinea being abused by a powerful rogue. According to a French poll, 60% of DSK’s country people believe that he has been set up by political opponents. The man himself says that the sex was consensual.
The transparent U.S. court process promises to make this a media event rivalling the OJ Simpson trial. But whatever the verdict, DSK’s career is on the scrap heap. The reemergence of all-but-forgotten allegations of sexual abuse by two other women has seen to that.
We might never really know whether DSK is the victim of a classic “honey trap”, or is a lecherous rapist. But apart from launching a 1 000 opinions, i i hi his t troubles bl d do provide id a new focus for those watching global power shifts. For decades, the rich countries have followed a simple tradition on the twin Bretton Woods multilaterals — a European is managing director of the IMF and an American heads the World Bank. This is so entrenched that media pundits make French finance minister Christine Lagarde the favourite to succeed DSK.
The real succession discussions, though, should provide a reminder that leaders of developing countries are tired of such traditions. They have long grumbled about an oldboys’ club that forgets that half the world’s economic activity and 80% of its growth is now generated outside the rich north. That it comes from countries home to nine in every 10 people on Earth.
Last Wednesday, Finance Minister Pravin Gordhan issued a statement reminding us of an agreement that “a transparent and competitive process” would be used in future on appointments at the IMF and World Bank. He added: “There are several candidates from developing countries who are credible and are eminently suitable to run the IMF.”
That Gordhan’s former boss, T Trevor Manuel, M li is one of f th those candidi dates hasn’t escaped anyone. Including online bookmakers who put his chance of succeeding DSK at six to one. His only serious emergingmarket competitor, according to the bookies, is Turkish economist and former United Nations Development Programme head Kemal Dervis, at odds of three and a half to one.
Most of the cash, though, has been put on the tradition continuing.
Lagarde is even-money favourite to become DSK’s successor at the IMF with Italian central bank governor Mario Draghi, who is next favoured at two to one. The other European on the bookies’ shortlist is the Swiss Josef Ackermann, currently CEO of Deutsche Bank. His odds are four to one. For the adventurous, you can get 250 to one on Allan Greenspan making a spectacular return. But given the way global power is moving, I wouldn’t mind a little of that six to one on Manuel. • Alec Hogg is the founder and editor-in-chief of Moneyweb. He presents Market Update with Moneyweb THE size of South Africa’s total listed-company universe means that local stock-market indices are dominated by a handful of large companies. As a result, many local asset managers with broad equity mandates may be forced to hold certain shares simply because of their index weightings, often with little difference in the shareholdings of two funds in the same category.
We typically see quite a large overlap among the top shareholdings of asset managers in the various equity sub-categories. Funds with similar benchmarks can easily overlap by more than 50%.
It is this overlap that can expose private investors with too many ac- tively managed unit-trust funds to the threat of closet indexation.
Closet indexation occurs when an investor buys such a wide range of investment funds that he or she ends up with the market return. The more funds you put into your collection, the more your net performance resembles that of the overall index. And that’s not the outcome you expect for the extra fees you pay your active fund-management team.
While the investment return from an actively managed fund is a function of the skill of the manager, as well as the manager’s ability to translate his or her market insights into the portfolio construction, it is the breadth of the opportunity set that is essential. Asset managers will be most effective with the fewest possible constraints.
Instead of focusing only on asset allocation or money-market funds, investors need to consider opportunities from the different branches of the family tree of investing — represented in the unit-trust space by categories such as offshore, equities, property, fixed income and asset allocation.
The “family tree of investing” concept refers to a mathematical technique where funds with similar performance profiles are grouped. This usually produces clusters of funds with similar underlying asset exposures and performance drivers.
The family tree offers deeper analytical insight into returns across asset classes than the familiar Asisa (Association for Savings and Investment SA) fund categories.
By analysing the overlap between funds and portfolios in terms of per- formance and actual shareholdings, I believe the best way to attack closet indexation is to implement an appropriate diversification strategy. But diversification cannot be achieved by buying an endless succession of asset-allocation funds. Choosing multiple funds offering similar strategies is not proper diversification.
A carefully structured selection of dissimilar funds diversifies a portfolio and spreads the investor’s risk. A idea is to use a multi manager fund. Multimanager funds offer a degree of diversification that is not easy to achieve in a single-manager fund. • PPS has over 200 000 members who have access to a suite of financial and health-care products to meet the needs of graduate professionals.
Alec Hogg is the founder and editor-in chief of Moneyweb.
David Green, chief investment officer at PPS Investments.