31 May 2017
INVESTING 23
ANDRIETTE THERON Senior Investments Analyst, PPS Investments
Why manager diversification is important
UK election has economic implications
It is widely accepted that portfolios should be diversified across securities, asset classes and geographies to include many uncorrelated sources of returns and minimise the impact of short term volatility of any of these factors.
Manager-specific risk is probably the most unappreciated diversifiable risk that investors face. As a multi-manager, we provide investors with that additional layer of diversification by combining asset managers with different but complementary investment strategies.
But why not simply invest in the top-performing manager? The simple answer is that the topperforming manager is highly unlikely to be the best performer all the time.
The asset manager ranking table clearly shows just how volatile and unpredictable the relative returns of asset managers are over the short term. Each colour represents one of the largest asset managers in South Africa, while each column represents the relative ranking of the managers in each calendar year since we launched the business. We can see from the random distribution of colours, that it is indeed impossible to predict with any confidence which the best-performing manager will be over the next 12-month period, purely based on performance over the most recent 12-month period.
An investor that allocated capital to Manager A based on strong performance in 2008 would have been disappointed by poor relative performance during 2009 and 2010. If the investor capitulated in 2011 and switched out of the strategy in search of better returns, the investor would have missed out on the strong performance delivered by Manager A during the year. It does not matter when the investor made the initial investment( whether it is 2008, 2011 or 2013), the pattern repeats itself. Part of the reason for this variability, is that investment strategies perform differently during various market and economic environments. Each asset manager has a fairly unique approach to investing that gives rise to managerspecific risk. An asset manager’ s investment strategy does not only determine how an investment idea pertaining to a security or asset class level is evaluated( e. g. focus on earnings growth, quality of management, providing sufficient margin of safety etc.), but also the weight it could carry in the portfolio( extent to which the manager is willing to allocate to the idea). As a result, different asset managers could have very different views or positions on the same investment with the same information at hand.
When we launched the business in mid-2007, little did we know that we were about to face the worst financial crisis since World War II. Almost a decade later, investors are still dealing with the after effects of extremely accommodative monetary policies across most of the developed world. How asset managers were positioned to take advantage of the events that transpired over the past decade depended on the managers’ investment strategy.
For example, a value-orientated manager had to live with severe underperformance for lengthy periods of time as already cheap resource counters continued to underperform expensive multi-national industrial companies with better earnings visibility and attractive dividend prospects, in a low-yield environment. A benchmark-focused manager, whose process is designed to establish positions in relative terms( underweight versus overweight), typically benefited more than a benchmark indifferent manager from the phenomenal growth of Naspers into a R1 trillion establishment, as the share became a significant holding in the Shareholder Weighted Index( from 1.6 % a decade ago to 18.6 % at quarter end). The extent to which fixed income investors were affected by the write-down of African Bank debt in 2014 was a function of the managers’ ability to appropriately assess the underlying credit risk and willingness to move down the capital structure for additional yield pick-up.
The UK Government’ s decision to hold an early general election in June has some potentially significant economic implications. This is according to UK think-tank, The Centre for Economics and Business Research( CEBR).
On the upside, an increased Tory majority, which would almost certainly be the result of an election, will increase economic and policy stability and reduce the current sense of business uncertainty.
“ The Government’ s majority is thin at present and introducing unpalatable policies over the coming years would be difficult without more Tories in Parliament. Increased certainty should feed through into higher levels of business investment, supporting growth in the short term.
“ This is especially the case with respect to Brexit uncertainty, where Theresa May would have to lay out a more articulated vision to the electorate in the run up to the election.”
The CEBR says a colossal defeat for Labour, with the ousting of Jeremy Corbyn,“ would also allow a credible opposition party to emerge from the ashes and end the effective one party state that the UK has become.”
“ This can only be good for the economy. Just as competition leads to better outcomes in business, so too does competition in politics, with credible political parties competing to deliver the policies which best guarantee prosperity for the nation.”
There are, however, some economic downsides to an early general election and a larger Tory majority, the CEBR notes.
“ While the Government increasingly seems to be taking a more moderate( and economically sensible) stance on issues such as immigration, reflecting the realpolitik and need for pragmatism post-Brexit, this could unravel.
“ Hardliners within the Conservatives could give Theresa May a difficult time over any softening in stance towards Europe. And she could be pushed into taking a hardline stance by the media during the election campaign – expect her to be repeatedly challenged on how and to what extent the Tories will reduce immigration.”
According to the CEBR, the politics of Theresa May is markedly different to the metropolitan liberalism of David Cameron and George Osborne.
“ It is more parochial and more anti-business. There is a risk that, with a bigger majority, she introduces policies which are detrimental to entrepreneurship – from higher taxation to migration restrictions.
“ This would be the wrong set of policies during an era in which being internationally competitive and attractive are so important.”