Fund managers with a strong bias towards value-style investing again dominated the top positions at this year’s Raging Bull Awards. Two of the top three companies have a value or valuation-based investment style, while the third employs independent managers that tend to have a value or valuation-based style.
The awards for unit trust performance to the end of December last year tracked periods in which the market crash that followed the credit crisis in 2008 loomed large, so it is not surprising that the top-performing fund managers – Allan Gray, Nedgroup Investments and Prudential Portfolio Managers – have an investment approach that focuses on reducing the risk of their clients losing money.
Managers that follow the value or valuation style invest with a margin of safety by selecting securities that are undervalued and the prices of which have been sold down so far that they are unlikely to fall much further. Value managers pick undervalued securities that have good potential to return to fair value, or higher, over the longer term.
Avoiding the risks inherent in investing in expensive popular securities also resulted in Allan Gray, Nedgroup Investments and Prudential Portfolio Managers taking the top three spots at last year’s management company awards. Last year, Prudential was in second position and Nedgroup in third, whereas this year Nedgroup was second and Prudential was third. At the 2009 awards (for performance to the end of 2008), two of these managers again emerged on top: Allan Gray (first) and Prudential (second). Oasis, another value manager, was in third place.
Allan Gray won the Raging Bull Award for the top domestic management company for the third year in a row this year since it first qualified for the award in 2009.
The management company rankings are determined on a quarterly basis from the risk-adjusted performance of the companies’ qualifying funds as measured by the PlexCrown Fund Ratings.
The PlexCrown ratings provide a single rating for each qualifying fund based on five different measures of risk-adjusted performance (or four in the case of asset allocation funds) over various periods up to five years, with greater emphasis on the longer performance periods. Qualifying funds have at least a five-year track record and are in unit trust sub-categories where performance can be compared.
The leading managers for each quarter are determined from the average of the ratings that the managers obtain for each of their funds in various sub-categories, such as domestic equity or domestic asset allocation. These averages are used to determine an average domestic rating and an average foreign rating. These two ratings are combined, with the domestic average accorded a 75-percent weighting, to determine the leading managers.
Allan Gray has been the top-performing domestic management company for every quarter since the first quarter of 2008 to the quarter to the end of December last year.
The company first qualified for inclusion in the management company rankings in 2008, when its funds obtained long enough track records in each of the required unit trust sub-categories.
Nedgroup took the second place in the management company rankings to the end of December last year after being in either second or third position in the quarterly management company rankings seven times over the past four years.
Prudential has been in either second or third position in the management company rankings for all but three quarters over the past four years.
Prudential is happy to wear the value manager label, whereas Allan Gray refers to itself as a valuation-based manager.
The key difference between a value manager and a valuation-based manager is that whereas a value manager has a clear focus on value shares in equity markets, a valuation-based manager will invest in any share with a share price below the company’s value and earnings potential, regardless of whether or not the share is a value share.
Nedgroup partners with independent managers that manage its funds, and its manager selection process tends to favour value or valuation-based managers. In Nedgroup’s stable are committed value managers, such as Regarding Capital Management (RE:CM), Orthogonal and Foord; managers that focus on valuations to protect your money against market downturns, such as Prescient and Abax (formerly Polaris Capital); and even a manager with a quantitative process that favours value shares, Taquanta. (Quantitative analysis is a computer-driven analysis of the numerical data relating to shares or bonds, such as earnings and price-to-earnings ratios.)
While Allan Gray and Prudential are committed to their own investment philosophies, Nedgroup is committed to its philosophy on how to select managers that have proven philosophies.
But when it comes to performance, the three houses have different strengths, investment processes and fund offerings. To highlight the differences, it is useful to compare their core funds, which are in the following sub-categories: domestic equity general, domestic asset allocation prudential, domestic fixed-interest bond and foreign equity general. In looking at these core funds, this article has quoted performance data for the periods to the end of December last year – the latest quarterly data available when this article was written, and the data that was used to determine the leading managers for the 2011 Raging Bull Awards.
ALLAN GRAY
Founder Allan WB Gray started the investment company that bears his name in 1974. The privately owned asset manager today has R310 billion under management. Since Gray started investing clients’ money as an independent manager in the 1970s, his management house has used the same investment philosophy, which it calls fundamental, or valuation-based. In terms of this philosophy, Allan Gray seeks out shares and other securities that are priced well below what the manager regards as their intrinsic value and their earnings potential.
Allan Gray explains intrinsic value as the value a prudent businessman would pay for a company.
The manager analyses the shares in which it invests to determine their intrinsic value and the value of their future earnings. This kind of research is referred to as fundamental research or analysis.
When investors are most pessimistic and drive share prices below their intrinsic values, Allan Gray is likely to be most optimistic, because the margin of safety is greatest and there is the least potential for the price of the share to fall further. Investing in this way enables Allan Gray to reduce the losses in its portfolios when stock markets turn against investors.
Because Allan Gray invests when shares are out of favour and sells when the market price equals the business price, its portfolios often differ greatly from the average and from the benchmark for the port-folio. For this reason, Allan Gray is often referred to as a contrarian manager.
At times, especially when the market is irrational and share prices are extreme, causing already cheap shares to continue to fall and expensive shares to continue to rise, Allan Gray may under-perform its peers over the short term.
Because undervalued shares can continue to trade below fair value for some time, Allan Gray has a long-term investment horizon, usually four years.
As its investment approach includes a margin of safety, Allan Gray’s performance relative to that of other managers is particularly strong during periods characterised by market downturns, such as the severe one of 2008.
But after a good year relative to its peers in 2008, Allan Gray has had two years of more mediocre performance relative to its peers. Last year in particular, a number of the manager’s funds under-performed their benchmarks and peers.
The manager had, relative to its peers, down-weighted its funds’ exposure to domestic equities. Allan Gray’s lower equity exposure was based on its view that economic and share-specific factors did not justify the valuations of local shares. In fact, the equity market rally went on for longer than expected.
In Allan Gray’s quarterly commentary in January this year, Rob Dower, the manager’s chief operating officer, reminded Allan Gray investors that there have been a number of occasions – some of them painfully long – when Allan Gray’s stock-picking decisions caused its funds to lag behind the market and their peers. The decisions tend to be vindicated over the long run, he says.
Allan Gray’s funds are invested more to protect investors from losing money than to capture short-term gains from market momentum, Dower says. The risks that worried Allan Gray last year – the weak local recovery and the fickleness of foreign investors – have become more worrying, and the potential for capital loss is greater, he says.
Despite its more recent under-performance relative to its peers, Allan Gray’s long-term performance carried it through, giving it the top score on its average PlexCrown rating and making it the leading management company in the ratings to the end of December last year based on performance periods up to five years. Allan Gray’s overall average PlexCrown rating was 4.625 (the highest score is five).
Domestic equity fund
Allan Gray has only one domestic equity fund. It manages the Equity Fund in the same way that it manages all its equity mandates, be they from its asset allocation funds or its segregated retirement funds.
Allan Gray notionally pools all its investments that have an equity mandate. The resulting portfolio is divided among Allan Gray’s equity portfolio managers (Duncan Artus, Delphine Govender, Andrew Lapping, Ian Liddle and Simon Raubenheimer), with the more senior managers receiving bigger portions of the portfolio to manage.
Allan Gray employs a number of analysts who are expected to research shares for all market sectors. Their research is used to compile a buy list of shares. The fund managers pick shares from the buy list in line with their ideas.
Although the buy list defines the investment universe, the decisions on which shares to buy, and in what quantities, are left to the individual portfolio managers. Unlike some large firms, Allan Gray believes that investment decisions are best made by individuals and not by committees.
Over the 10 years to the end of December last year, the Equity Fund was in second position out of 34 funds in the domestic equity general sub-category, with an annual return of 22.96 percent relative to the 20.8 percent returned by the FTSE/JSE All Share index (Alsi), according to ProfileData.
With shorter-term under-performance weighing more heavily on its five-year performance to the end of December last year, over this period the fund returned 14.9 percent a year, compared with the Alsi’s 15.23 percent, and was ranked 11th out of 64 funds.
On straight performance in the domestic equity general sub-category, the Allan Gray fund lagged behind Prudential’s Equity Fund and one of Nedgroup’s three equity funds, the Rainmaker Fund.
In terms of risk-adjusted performance to the end of December last year, the Allan Gray Equity Fund achieved four PlexCrowns and was ranked behind Prudential’s Equity Fund and Nedgroup’s Rainmaker Fund (R).
As Allan Gray’s Equity Fund is its only domestic equity fund, the manager also achieved four PlexCrowns as its domestic equity rating, scoring behind Prudential and Nedgroup, and was in sixth position among its peers.
Domestic bond fund
Allan Gray manages its Bond Fund on a bottom-up basis for total returns rather than relative to the All Bond index (Albi). It buys bonds when it believes they offer good value, and moves the fund into cash and money market assets when it thinks the outlook for cash is superior.
It aims to minimise the risks of loss – whether a credit loss or a loss through adverse interest rate movements – instead of managing the fund to the index. Even when it has a positive outlook on bonds, it is unlikely that the duration of the fund will materially exceed that of the Albi. The reason is that Allan Gray rarely finds the risk-return trade-off of the very long-dated government bonds appealing.
Little trading takes place in the Bond Fund, because Allan Gray believes it is very difficult to predict short-term movements in interest rates. The manager says it prefers to formulate a medium- to long-term inflation outlook and to optimise the position of the fund around that.
Over the five years to the end of December last year, the Bond Fund was ranked third out of 17 funds, with a return of 8.46 percent a year relative to the Albi’s 7.91 percent. On PlexCrown ratings to the end of December last year, Allan Gray’s Bond Fund achieved five PlexCrowns and was ranked second after Nedgroup’s Bond Fund.
Allan Gray has only one other fixed-interest fund, its Money Market Fund. Money market funds are not rated in the PlexCrown ratings, because they have such small differences in performance.
Therefore, Allan Gray’s average PlexCrown rating in the domestic fixed-interest sector was the same as that for its Bond Fund. Allan Gray tied with Nedgroup for first place in the management company rankings in this sector to the end of December last year.
Domestic asset allocation funds
Allan Gray is known in the asset management industry as a bottom-up manager: it looks for shares or other securities that are priced below their intrinsic value. When it can no longer find such shares, or bonds or listed property that offer better returns than cash, it allocates to cash (within the mandate of the relevant fund and the constraints of the unit trust sub-category) until the right opportunities arise. Allan Gray believes that this bottom-up approach is more successful than trying to predict which markets and market sectors will perform well – as top-down managers attempt to do.
Top-down asset allocation managers decide how much of a fund to allocate to each asset class before they look for opportunities within the class.
In addition to its valuation-based investment philosophy and bottom-up approach, Allan Gray at times enhances the performance of its asset allocation funds with hedging strategies. For example, it may sell Alsi futures when the market looks expensive and close this position when, inevitably, the market falls.
Allan Gray has two domestic asset allocation funds that qualify for PlexCrown ratings and hence contributed to its overall winning performance.
The Balanced Fund is a prudential variable equity fund. The fund achieved a strong return of 19.44 percent a year over the 10 years to the end of December last year, making it the leading fund in its sub-category out of 15 funds over that period. However, the Balanced Fund’s return over the five years to the end of last year was a more muted 12.64 percent a year, and it was ranked fourth out of 44 funds.
The fund achieved four PlexCrowns for the periods up to five years to the end of December last year.
Allan Gray’s second qualifying asset allocation fund is its Stable Fund, a prudential low-equity fund. This fund, which was the only fund in its sub-category with a 10-year performance history to the end of December last year, returned 13.61 percent a year. Over the five years to the end of December last year, the fund was ranked second out of 29 funds, with a return of 10.58 percent a year.
The Stable Fund achieved five PlexCrowns for the periods to the end of December last year.
Allan Gray has one other domestic asset allocation fund, the Optimal Fund, but this fund is in the targeted absolute and real return sub-category. As these funds have mandates - and hence returns - that differ widely, they are not included in the PlexCrown Fund Ratings and so do not contribute to a manager’s performance for the purpose of determining its place in the management company rankings.
The PlexCrown ratings that Allan Gray obtained for its Stable Fund and Balanced Fund gave Allan Gray an average PlexCrown rating of 4.5 PlexCrowns for domestic asset allocation funds.
Allan Gray is usually a strong performer in the asset allocation sector, often leading the sector.
However, based on the PlexCrown ratings for the periods to the end of December last year, Allan Gray was placed fifth among its peers, with Investment Solutions, Rezco, Prescient and Coronation coming in ahead of Allan Gray. Among the top three managers overall, however, Allan Gray was ahead of Nedgroup and Prudential in the domestic asset allocation sector.
Foreign funds
Allan Gray’s rand-denominated foreign funds are either feeder funds or funds of funds that invest in the funds of Orbis, its offshore sister company. These funds have been approved as suitable for the South African market by the Financial Services Board (FSB).
Orbis was founded by Gray in 1987 and follows the same investment philosophy as the local manager. Orbis funds are domiciled in Bermuda, the company’s headquarters, but Orbis has investment professionals around the world.
Allan Gray’s foreign equity general fund, the Allan Gray-Orbis Global Equity Feeder Fund, invests into the United States dollar-denominated Orbis Global Equity Fund.
The Global Equity Fund invests across the US, Europe and Asia. The fund’s strengths lie in its stock-picking in line with the Allan Gray and Orbis investment philosophy. In addition, Orbis manages the currency exposure of its funds in light of currency valuations and expected trends.
The Global Equity Fund has in US dollars returned 5.3 percent a year over the five years to the end of December last year relative to the 3.3 percent returned by its benchmark, the FTSE World index.
The Feeder Fund is subject to the fortunes of the rand, as are all rand-denominated foreign funds. It returned 5.67 percent a year in rands over the same five-year period relative to its benchmark, the MSCI, which returned 1.29 percent in rands. The Feeder Fund was ranked first out of 28 funds over five years in the foreign equity general sub-category.
The Feeder Fund was well ahead of the foreign equity general funds of competing managers Prudential and Nedgroup.
The Global Equity Feeder Fund obtained five PlexCrowns for the periods to the end of December last year.
At this year’s Raging Bull Awards, Allan Gray collected an award for the Feeder Fund as the top performer in the foreign equity general sub-category over the three years to the end of December last year and a certificate for the Feeder Fund’s risk-adjusted performance over five years.
In the PlexCrown ratings of offshore managers, Orbis was ranked second for the periods to the end of December last year, reflecting the strong overall performance of this house.
Orbis’s longer-term track record carried its and Allan Gray’s foreign funds through despite what Orbis said was a tough 18 months to the end of December last year, when the Global Equity Fund under-performed its benchmark by 13.7 percentage points.
Allan Gray has two other rand-denominated foreign funds, but only one receives a PlexCrown rating and influences Allan Gray’s average PlexCrown rating for the management of foreign funds and hence its overall average score. Both funds are foreign asset allocation funds.
The Allan Gray-Orbis Global Optimal Fund of Funds, which seeks to earn positive returns by using hedging, is too new to qualify for a PlexCrown rating.
The Allan Gray-Orbis Global Fund of Funds also invests in underlying Orbis funds but does not make use of hedging.
The Global Fund of Funds achieved five PlexCrowns for the periods to the end of December last year. This gave Allan Gray an average rating of five PlexCrowns for rand-denominated foreign funds and the top spot in the rankings for the management of foreign funds. In these rankings, Allan Gray was followed by Prudential in joint second position with Oasis and Coris, while Nedgroup came joint fifth with Investec.
Strengths and weaknesses
PlexCrown Fund Ratings analysed the returns of Allan Gray’s Equity and Balanced funds over the three years to the end of December last year to identify its style biases. Its findings of these funds’ average mix of shares and other investments are outlined in the table (see link at the end of this article).
Ryk de Klerk, the executive director of PlexCrown Fund Ratings, says the composition of the funds, especially that of the Equity Fund, explains why the funds and the investment house tend to under-perform other asset managers during strong domestic equity bull markets in the asset classes where they compete and, conversely, why Allan Gray and its funds significantly out-perform in weak or bear markets.
PlexCrown has developed its own risk classification scale to rate the risk of funds based on their risk of under-performing cash – known as their downside risk rating. Funds’ rolling monthly returns over seven years are taken into account and compared with those of their peers in the main unit trust sub-categories. Funds are accorded a rating of one to 10, with one the lowest downside risk rating.
The average downside risk rating of the equity general sub-category is 7.4, while the Allan Gray Equity Fund’s downside risk rating was seven.
Due to its diversification into foreign markets and its high exposure to cash, the downside risks of Allan Gray’s funds tend to be lower than those of the average of their peer groups, De Klerk says.
The Allan Gray Balanced Fund’s risk rating is three, compared with the 4.3 average of the domestic asset allocation prudential variable equity sub-category.
De Klerk says that Allan Gray may not provide you with market returns in a strong bull market, but during bear markets the manager will lose less money on your behalf than many other houses.
NEDGROUP INVESTMENTS
Nedgroup Investments is the product of a merger of five different management companies seven years ago: Nedbank, BoE, African Harvest, Nedcor Investment Bank (NIB) and Franklin Templeton NIB Investment. Since the merger, assets under management have grown from R7 billion to R90 billion.
Nedgroup does not have its own investment management team that manages its funds. Instead, Nedgroup’s small team has specialised in researching, selecting and monitoring mostly independent fund managers to which it outsources the management of its funds. These fund managers are what Nedgroup regards as the “best of breed” managers in the market.
Nic Andrew, the head of Nedgroup Investments, says Nedgroup looks for managers that not only have a track record of producing good performance but that do so because of their proven and consistent investment philosophy.
Managers must have a rigorous and repeatable investment process, and they must perform consistently in terms of that process, Andrew says.
The long-term past performance of any potential manager is analysed through different market cycles, and this helps Nedgroup to understand a manager’s strengths and weaknesses and when to expect inevitable periods of under-performance.
However, Nedgroup Investments does tend to favour managers with a long-term focus that invest with the valuations of the securities they select in mind, Andrew says.
Nedgroup looks for managers that think differently and are not influenced by the crowd, he says. Managers must be able to withstand the stress of under-performing at times and stick to an investment philosophy even if it is not successful over the short term. The managers that Nedgroup chooses are also willing to take active decisions - that is, invest away from the index if need be, Andrew says.
Good managers tend to have a high level of conviction, and this is usually reflected in the low number of stocks in their portfolios: they take bigger bets on fewer shares, he says.
Nedgroup’s managers do not make investment decisions in large committees, because this leads to investments being made with less conviction and less success than is the case when decisions are made by key individuals, Andrew says.
“Best of breed” managers tend to be bottom-up stock-pickers that know their shares well and do not rely overly on unreliable forecasts about the economy, the currency or interest rates to make investment calls, he says.
Nedgroup looks for certain features in the businesses of the managers that it selects, Andrew says. Ideally, they must be owner-managed and must invest a significant portion of their own money in the same or a similar portfolio to the one that they manage. This creates an alignment of interests, he says.
The managers should also be able to close their funds or businesses when they become too big, because they know that the size of assets under management can affect performance, Andrew says. This is particularly relevant in South Africa, where the number of shares on the stock market is limited and the number of tradeable shares is even smaller, he says.
As the size of a manager’s assets under management increases, a manager will be forced either to pick stocks that are not as good or to buy larger stakes in existing holdings. A manager can find it difficult to get out of larger stakes quickly.
As a result of Nedgroup applying the above factors when outsourcing the management of its funds, Nedgroup has favoured smaller boutique managers, such as Abax, Foord, Orthogonal, Prescient, RE:CM and Taquanta.
Domestic equity funds
Nedgroup Investments has three domestic equity general funds. Its most popular fund, with R11.8 billion invested in it, is the Rainmaker Fund, which is managed by Tim Allsop, one of the founders of Abax.
Omri Thomas, formerly the chief investment officer at Sanlam Investment Management, co-manages the fund with Allsop.
Allsop ran the Syfrets Prime Select Fund with an enviable track record in the late 1990s and early in 2000. He then moved to African Harvest and began to manage the Rainmaker Fund. The Prime Select Fund and the Rainmaker Fund were later merged and continued as the Rainmaker Fund. This fund was taken over by Nedgroup when it bought African Harvest.
Abax specialises in fundamental research (researching the fundamentals of each business in which it invests) and in stock-picking. It tends to pick cheap shares that have good growth prospects and a compelling advantage over their competitors.
Andrew says that in managing the Rainmaker Fund, Abax takes big active decisions that can result in significant out-performance or under-performance over shorter terms. The fund tends to have certain core holdings that it holds for the long term. The fund trades around these core holdings in other holdings based on their valuations.
Abax is described in Nedgroup literature as active, conscientious and decisive.
The Rainmaker Fund won a Raging Bull Award for the top equity general fund on a risk-adjusted basis in 2005.
Rainmaker was Nedgroup’s top-performing domestic equity general fund over the five years to the end of December last year. Over this period, it was ranked 10th out of 64 funds in the equity general sub-category, with a return of 15.23 percent a year. Among the equity general funds run by the top three managers, it is the second-best-performing fund over this period, after Prudential’s Equity Fund.
The Rainmaker Fund received four PlexCrowns for periods up to the five years to the end of December last year. It was ranked just above Allan Gray’s Equity Fund but below Prudential’s Equity Fund.
For investors who want a more conservative approach than that adopted by the Rainmaker Fund, Nedgroup offers its Equity Fund, which is managed by a team that has, in Nedgroup’s words, an unwavering belief in value investing.
The fund is managed by Rowan Williams-Short, a die-hard value manager, and Douw Steenekamp. The pair are the co-founders of Orthogonal.
This is the second time that Williams-Short has managed the Equity Fund. He co-managed the fund between November 2003 and November 2004 while he was at African Harvest. Williams-Short worked for Prudential Portfolio Managers and African Harvest and in Nedgroup Investments’s London office before he returned to South Africa to start Orthogonal in 2007.
Steenekamp made a name for himself at Old Mutual, where he managed the High Yield Opportunity Fund, which focuses on investing in shares that yield high dividends.
Nedgroup describes Orthogonal as a team that is not influenced by market views but is nevertheless very risk-focused.
Williams-Short and Steenekamp took over the management of the Equity Fund late in 2007, inheriting the fund’s rather poor track record from African Harvest. Its five-year track record is still relatively poor, but the fund’s ranking among its peers improved over the three-year period to the end of December last year.
Over the five years to the end of December last year, the Equity Fund returned 11.79 percent a year and was ranked 42nd out of 64 funds in its sub-category. Over the three years to December last year, the fund returned 6.21 percent a year and was ranked 32nd out of 88 funds in its sub-category.
The fund achieved three PlexCrowns over the five- year period to the end of last year.
Nedgroup’s third equity fund, the Quants Core Equity Fund, is managed by Richard Gosnell of Taquanta Asset Managers.
The fund actively picks shares using a quantitative process that Taquanta calls price-indifferent investing. This process favours cheaper, higher-yielding shares and reduces its exposure to shares that have out-performed and become relatively expensive.
Taquanta says its process tilts its portfolios towards value shares that have a high probability of out-performing over the longer term.
The Quants Core Equity Fund was ranked 15th out of 64 funds over the five years to the end of December last year, with a return of 14.76 percent a year.
The fund achieved a PlexCrown rating of four PlexCrowns for periods up to the five years to the end of December last year.
Together, the ratings of the Rainmaker, Equity and Quants Core Equity funds gave Nedgroup an average score of 3.67 PlexCrowns for the management of domestic equity general funds for the periods to the end of December last year.
Nedgroup has a number of other domestic equity funds that scored well in the PlexCrown rating system, and these funds raised its average PlexCrown rating for domestic equity funds.
The Value Fund, managed by Dave Foord of Foord Asset Management, the Growth Fund, managed by Neil Brown of Old Mutual Investment Group South Africa, and the Financials Fund, managed by Kokkie Kooyman of Sanlam Investment Management, all achieved five PlexCrowns for their risk-adjusted performance to the end of December last year.
The Entrepreneur Fund, managed by Anthony Sedgwick of Abax, and the Mining and Resources Fund, managed by Gary Quinn of Prudential Portfolio Managers, each achieved four PlexCrowns.
These five funds, plus the three equity general funds, gave Nedgroup an average score of 4.25 PlexCrowns for the management of domestic equity funds for periods to the end of December last year. As a result, Nedgroup was ranked higher than Allan Gray (an average of four PlexCrowns) but below Prudential (an average of 4.5 PlexCrowns) on risk-adjusted performance in the domestic equity sector for the periods to the end of December last year.
Bond fund
At this year’s awards ceremony, Nedgroup’s Bond Fund received the Raging Bull Award for the top-performing domestic fixed-interest fund (that is, the top fund out of all the funds in the domestic fixed-interest bond and income sub-categories) over the three years to the end of December last year.
It also received a certificate for the best domestic fixed-interest bond fund over the three years to the end of December last year and a certificate for the best bond fund on a risk-adjusted basis over the five years to the end of December last year.
The Bond Fund has been managed by Guy Toms and Eldria Fraser of Prescient Investment Management since it was launched in November 2003.
Andrew says that Prescient uses quantitative methodologies to select bonds in which to invest, and that selection may be quite different from the index.
Prescient tends to be more of a bottom-up manager, whereas many bond funds are managed on a top-down basis, with the duration (or term to maturity) of the bonds chosen to suit the manager’s expectations of the market, Andrew says.
The Bond Fund earned 8.78 percent a year over the five years to the end of December last year, placing it first out of 18 funds. Its benchmark, the South African Bond index, returned 7.91 percent a year over the same period, according to ProfileData.
The fund achieved five PlexCrowns for its risk-adjusted performance over periods up to the five years to the end of December last year. It narrowly beat Allan Gray’s Bond Fund, which also achieved five PlexCrowns. It was well above Prudential’s Bond Fund, which achieved only three PlexCrowns.
Nedgroup also has the Money Market Fund and the Flexible Income Fund in the domestic fixed-interest sector. Neither the Money Market Fund nor the Flexible Income Fund is rated, because their sub-categories are excluded from the ratings. The Flexible Income Fund is in the varied specialist sub-category, which is not rated, because the funds have widely differing mandates.
As a result, Nedgroup’s average score for domestic fixed-interest funds was the same as the PlexCrown rating of its Bond Fund, five PlexCrowns, which put it in first position in this sector, tied with Allan Gray, for periods up to the end of December last year.
Domestic asset allocation funds
In the domestic asset allocation sub-categories, Nedgroup has two prudential variable equity funds, a prudential low-equity fund, and two targeted absolute and real return funds.
The low-equity Stable Fund does not have a long enough track record to qualify for a PlexCrown rating, while targeted absolute and real return funds are not rated because of their widely differing mandates.
One of the two prudential variable equity funds, the Managed Fund, is managed by Piet Viljoen of RE:CM, while the other, the Balanced Fund, is managed by Williams-Short and Dudu Tembo, also of Orthogonal.
Andrew says that Viljoen is a strong believer in the value philosophy and a committed bottom-up asset allocator. He buys the shares of high-quality companies that are cheap. When Viljoen can no longer find such shares, he is not shy to move strongly into cash, at times placing up to 50 percent of his fund in cash, Andrew says.
The Managed Fund (R) was eighth out of 44 funds in the prudential variable equity sub-category over the five years to the end of December last year, with a return of 11.62 percent.
The Balanced Fund is now also managed on a bottom-up basis, and Orthogonal has a strong value bias.
Andrew says Orthogonal does consider the relative valuations of the different asset classes, and Williams-Short’s team analyses the fixed-interest market in detail.
Another difference between the Managed Fund and the Balanced Fund is that the Balanced Fund has a socially responsible angle.
A portion of the fee income earned by Nedgroup is donated to community organisations. The current beneficiaries include Nicro’s Community Victim Support Service, Childline South Africa, Rape Crisis and Habitat for Humanity.
Although the fund’s relative short-term performance has improved since it was taken over from African Harvest by Orthogonal, its three-year and longer track records were still poor to the end of December last year: it was ranked 50th out of 58 funds, with a return of 3.17 percent a year over three years, and 37th out of 44 funds, with a return of 8.26 percent a year over five years.
The Managed Fund scored four PlexCrowns and was ranked eighth in its sub-category, but the Balanced Fund scored only two PlexCrowns.
The Balanced Fund’s rating diluted the Managed Fund’s rating, giving Nedgroup an overall average score of three PlexCrowns for asset allocation. This put it in joint 28th position among its peers for the management of asset allocation funds, way behind Allan Gray (fifth) and Prudential (seventh).
Foreign funds
Nedgroup Investments recently appointed a new manager of its rand-denominated foreign equity general fund, the Global Equity Feeder Fund.
The fund’s manager was formerly appointed by Nedgroup’s London office, but in the last quarter of last year, Nedgroup Investments’ South African office took over the appointment to ensure that a manager was appointed along the same lines as its local managers, Andrew says.
The local office appointed London-based Veritas Asset Management to run the fund. Like the other managers that Nedgroup has appointed, Andrew says that Veritas is independently owned and owner-managed and has a valuation-based approach.
It identifies themes and filters shares using quantitative analysis. Fundamental research is then conducted to ascertain if the share has a competitive advantage and is worth owning, but shares are bought only if the valuation is right, Andrew says.
Veritas runs high-conviction portfolios of 25 to 40 stocks. The company also has a focus on minimising the risk of permanent capital loss.
Most of the Global Equity Feeder Fund’s history over the five years to the end of December last year relates to its management by another British-based manager, Marathon Asset Management. Marathon is an owner-managed global equity investment firm with a long-term, contrarian value style based on analysing returns and capital flows. Marathon closed its fund to new investments for a number of years. It then agreed to take new investments in a new fund with a new fee structure, Andrew says.
The Global Equity Feeder Fund was briefly managed by another manager before Nedgroup found and engaged Veritas.
The fund was ranked 15th out of 29 funds in the foreign equity general sub-category over the five years to the end of December last year, with a return of 1.72 percent a year.
The Global Equity Feeder Fund achieved a rating of three PlexCrowns for periods up to the five years to the end of December last year. As the fund is Nedgroup’s only foreign equity fund, this was also the manager’s score in the foreign equity sector, where Nedgroup was ranked joint seventh with Prudential. Allan Gray was ranked first.
Nedgroup has two other funds that invest in foreign markets that are ranked in the PlexCrown system. In the worldwide asset allocation flexible sub-category, the Bravata Worldwide Flexible Fund is managed by Walter Aylett of Aylett and Company. Aylett is also a value manager and was a former star manager at Coronation. The Worldwide Flexible Fund achieved four PlexCrowns for its risk-adjusted performance for periods up to five years to the end of December last year.
The Global Balanced Feeder Fund is a foreign asset allocation fund managed by London-based asset manager Sarasin & Partners.
Sarasin’s good performance has been recognised in the Raging Bull Awards previously. In recent years it has won awards for its CI Globalsar Sterling Balanced Fund and its EquiSar Thematic Dollar Fund.
Nedgroup’s Global Balanced Feeder Fund achieved three PlexCrowns for periods up to the five years to the end of December last year.
The average rating of Nedgroup’s three foreign funds was 3.25 PlexCrowns, placing it in joint fifth position among its peers for the management of foreign funds to the end of December last year.
It was ranked behind Allan Gray and Prudential for the management of foreign funds.
Strengths and weaknesses
The results of PlexCrown’s return-based analysis of the average asset composition of Nedgroup’s equity and prudential funds over the three years to the end of December last year are outlined in the table (see link at the end of this article).
De Klerk says while it is evident that the objectives of Nedgroup’s funds in their respective asset classes differ distinctly from each other, the value bias is the golden thread that runs through all the funds.
Both the Equity and the Quants Core funds are virtually 100-percent concentrated on the South African market and are fully invested, he says.
The Rainmaker Fund is more diversified, though, with exposure to foreign equities and other South African equities and a relatively high cash holding.
De Klerk says the Balanced Fund is fully invested in equities (prudential funds can have a maximum of 75 percent in equities), with a high exposure to foreign equities, while the Managed Fund’s equity exposure is significantly lower, with a stronger value bias.
The house tends to outclass its peers in weak domestic equity bear markets in the asset classes where it competes but under-performs its peers during strong or bull markets, he says.
The downside risk ratings of Nedgroup’s funds also differ distinctly from each other in their respective asset classes, De Klerk says.
On the PlexCrown risk classification scale, the Rainmaker Fund’s downside risk is six, compared with the 7.4 average of the domestic equity general sub-category, while the Quants Equity Fund’s risk rating is seven, he says.
The risk rating of the Equity Fund, eight, is higher than the average, he says.
The Managed Fund’s downside risk rating is four, compared with the 4.3 average of the domestic asset allocation prudential variable equity sub-category. But the risk rating of the Balanced Fund is significantly higher, at six.
It is evident that some of the house’s funds will out-perform their peers in strong bull markets and under-perform in bear markets. The track records of other funds, such as the Rainmaker Fund and the Managed Fund, that have downside risk ratings that are significantly lower, are likely to be the opposite. These funds will under-perform in bull markets and out-perform in bear markets, De Klerk says.
PRUDENTIAL PORTFOLIO MANAGERS
Prudential Portfolio Managers is 75-per-cent owned by London-based M&G Limited, which in turn is owned by Prudential plc, the British financial services group. The local manager has R100 billion under management.
Prudential follows what it calls a prudent value philosophy. John Kinsley, the managing director of Prudential Portfolio Managers Unit Trusts, says that while Prudential follows the traditional value manager philosophy, it also takes into account the risks of the shares or other securities in which it invests. Prudential will manage its exposure to these value positions in line with the mandate of the relevant fund or the other portfolio.
The manager will not buy shares when they are expensive or significantly above fair value.
Prudential begins by identifying shares that are cheap, based on their earnings and their dividend yield, and also based on whether the current price is cheaper or more expensive than the company’s net asset value in terms of the share’s history and compared with the market.
Therefore Prudential typically selects shares with lower-than-average price-to-book ratios or price-to-earnings ratios or with high dividend yields. Prudential sifts through this list of cheap shares and discards those that are cheap but priced correctly – or cheap for a good reason – for example, a company that is facing the threat of bankruptcy. This process leaves Prudential with shares that appear to be undervalued relative to what Prudential believes is their fundamental value or the value of the underlying business based on its characteristics. These shares are analysed on the basis of a balance between potential risk and reward.
Recognising that shares and securities, and the markets on which they are traded, are inherently unpredictable, Prudential takes modest positions and constantly measures the “riskiness” of its portfolios. The aim is to be aware of, and to manage any unintended exposure to, any one characteristic that is considered to have the potential for “undue risk”. Prudential says this risk control is what differentiates it from other value managers.
Prudential says it carefully controls the extent of its exposure to value shares. Its share holdings relative to the benchmark of a portfolio will reflect the strength of its convictions.
Its tracking error – a measure of risk based on the portfolio’s variance from the benchmark – will therefore vary, depending on how favourable Prudential feels the markets are for stock-picking.
When there is a big gap between the earnings yield of a basket of value shares and the earnings yield of a basket of growth shares, you can expect Prudential to move away from the benchmark significantly to take advantage of these opportunities.
The manager actively measures and monitors risk statistics, taking into account which risks are a result of sector exposure, style exposure and exposure to the fund’s particular benchmark. The remaining risk exposure – what is left unexplained by sector, benchmark and style factors – is stock-specific risk.
Prudential says it believes it needs a fairly large, but carefully managed, exposure to this risk to out-perform the market.
As a prudent value investor, Prudential is a long-term investor, because the market price of an asset may take a long time to return to its intrinsic value. Prudential says it is more comfortable with achieving steady incremental returns above the benchmark or its peers than in taking performance in a few big bites. Incremental returns tend to produce more certainty for investors, it says.
Prudential will not pursue short-term gain at the expense of long-term value or chase market share at any price. This investment philosophy also helps Prudential to decide how much to invest at country allocation level for international portfolios, and at asset allocation level in the equity, fixed-interest and cash markets.
Prudential has a focused range of funds that it believes will meet the needs of most investors.
Domestic equity funds
Prudential’s Equity Fund has been managed jointly by Gary Quinn and Chris Wood for a number of years.
They choose stocks carefully in line with Prudential’s value philosophy, because Prudential prefers to hold on to stock picks for as long as possible in order to participate in maximum long-term earnings growth potential. On average, the fund holds about 35 stock positions.
The Equity Fund won a Raging Bull Award in 2008 and in 2009 for its risk-adjusted performance over the periods to the end of December 2007 and 2008 respectively.
Over the periods to the end of December last year, the fund scored five PlexCrowns but was ranked fourth behind Marriott’s, Foord’s and Kagiso’s funds in the equity general sub-category.
The Prudential Equity Fund out-performed the Allan Gray Equity Fund and Nedgroup’s Rainmaker Fund on risk-adjusted performance and straight performance over periods up to the five years to the end of December last year. The Prudential Equity Fund returned 17.04 percent a year over the five years to the end of December last year and was ranked third out of 64 funds in its sub-category.
Prudential also has a domestic equity value fund, the Dividend Maximiser Fund, which obtained four PlexCrowns for the periods to the end of December last year.
Together, the Equity Fund and the Dividend Maximiser Fund gave Prudential an average rating of 4.5 PlexCrowns for the management of domestic equity funds, placing it ahead of both Allan Gray and Nedgroup in this sector.
Bond fund
As its name suggests, the Prudential High Yield Bond Fund focuses on bonds with high yields, including government-guaranteed bonds and corporate bonds.
Locally and globally, Prudential specialises in finding value in bonds by identifying those that are under-priced but paying a high yield.
In particular, its local and international bond teams specialise in finding good corporate bonds, doing their own fundamental research rather than relying on reports from credit rating agencies.
Kinsley says that Prudential’s parent company in London has one of the largest teams of credit analysts in London. This team specialises in seeking out corporate bonds that are paying a margin above the yield on government bonds. This margin more than compensates investors for the higher risk and lower level of liquidity (the ease with which they can be bought or sold) of corporate bonds.
Prudential’s local bond fund is co-managed by David Knee, who was formerly part of the London credit analyst team, and Gareth Bern. They, like the London team, seek undervalued bonds and, in particular, higher-yielding corporate bonds.
In this way, Prudential’s bond fund management is bottom-up, and Prudential does not use the typical top-down approach of trying to forecast the interest rate cycle and managing the fund’s average duration.
Over the five-year period to the end of December last year, the High Yield Bond Fund was ranked 10th out of 17 funds, and its annual return was 7.92 percent. The fund narrowly beat the SA Bond index, the benchmark for the sub-category, and its performance lagged behind that of Nedgroup’s and Allan Gray’s bond funds.
The fund achieved three PlexCrowns for its risk-adjusted performance to the end of December last year, coming in well below the risk-adjusted performance of the Nedgroup and the Allan Gray bond funds.
Prudential has three other domestic fixed-interest funds: the Money Market Fund, the Dividend Income Fund and the Enhanced Income Fund. None of these funds qualifies for inclusion in the PlexCrown ratings, because the former is a money market fund and the latter two are fixed-interest varied specialist funds, which are not rated.
Therefore, Prudential’s average score for the management of domestic fixed-interest funds was the same as its score for its bond fund, three PlexCrowns.
Domestic asset allocation funds
Prudential is known as a tactical asset allocation manager. It changes its allocations to the different asset classes depending on its outlook for the relevant financial markets.
However, Prudential begins with a strategic asset allocation – set allocations to each asset class that are informed by Prudential’s views on what each asset class is likely to return over the long term (10 to 15 years and through several cycles).
In formulating these long-term returns, Prudential relies on work done by its parent company in London, as well as the views of its local investment team. These views provide a long-term equilibrium, or fair value, for each asset class.
Where an asset class is priced well below fair value, the manager may make a tactical call to increase its exposure to that asset class.
Kinsley says the manager does not believe it is possible to time the markets, so it cannot say exactly when to buy or sell securities in a particular asset class. However, Prudential uses the equilibrium levels for the different asset classes as an anchor to determine when to be overweight or underweight in any particular asset class.
Prudential has two domestic asset allocation funds, but only one, its Balanced Fund (in the prudential variable equity sub-category), qualifies for inclusion in the PlexCrown Fund Ratings. The other fund is a targeted absolute and real return fund and so is not rated by the PlexCrown system.
The Balanced Fund is managed by Marc Beckenstrater, who is also Prudential’s chief investment officer. Cromwell Mashengete and Albert Arntz are co-managers with Beckenstrater and are responsible for the day-to-day implementation of the asset allocation decisions.
Once the asset allocation calls have been made, the management of the funds allocated to the different asset classes is the responsibility of the relevant team within Prudential.
For example, the equity team under Quinn manages the equity portion of the Balanced Fund, the bond team under Knee manages the bonds in the fund, and Arntz, the manager of the Enhanced SA Property Tracker Fund, guides the property part of the portfolio. These teams build the securities in their part of the portfolio on a bottom-up basis.
Over the five years to the end of December last year, the Balanced Fund returned 11.91 percent a year and was ranked sixth out of 44 funds in its sub-category. Over five years, the Prudential fund beat Nedgroup’s Managed and Balanced funds but not Allan Gray’s Balanced Fund. On PlexCrown ratings, the Balanced Fund achieved four PlexCrowns over periods up to five years to the end of December last year but was ranked behind both the Allan Gray Balanced Fund and the Nedgroup Managed Fund, which also achieved four PlexCrown ratings. It comfortably beat the Nedgroup Balanced Fund, which achieved two PlexCrowns.
As only one of Prudential’s funds is rated in the domestic asset allocation sector, the Balanced Fund’s score of four PlexCrowns determined the house’s rating for the management of domestic asset allocation funds for periods up to the five years to the end of December last year.
With Nedgroup scoring an average of three PlexCrowns and Allan Gray 4.5 PlexCrowns, Prudential was rated above Nedgroup but below Allan Gray for domestic asset allocation to the end of December last year.
Foreign funds
Prudential has only one foreign equity general fund, the Global Value Fund of Funds.
The fund invests in a number of underlying Prudential M&G Funds, such as the M&G North America Fund, the M&G European Strategic Value Fund, the M&G Pacific Market Fund, the M&G Recovery Fund and the M&G Prudential Japan Fund.
Kinsley says the Global Value Fund of Funds has been prevented from investing in some other M&G funds to which it would like to obtain exposure, because these funds have been registered in terms of European Union standards for collective investment schemes, known as Undertakings for Collective Investments in Transferable Securities.
In terms of South Africa’s Collective Investment Schemes Control Act, local fund of funds are entitled to invest in offshore-registered funds that are not registered with the FSB, but these offshore funds must comply with the same requirements as funds that do register with the FSB, Kinsley says.
Some of the M&G funds in which Prudential would like its Global Value Fund of Funds to invest do not meet these requirements. As a result, the fund has invested in exchange traded funds (ETFs) - which are also collective investment schemes - that represent the share markets in which Prudential cannot invest in its parent company’s funds.
For example, it is invested in the iShares S&P Global 100 Index Fund and the iShares MSCI Germany Index Fund. iShares, a major ETF provider globally, is part of the BlackRock group.
Over the five years to the end of December last year, the Global Value Fund of Funds returned 1.53 percent a year and was ranked 16th out of 29 funds. On PlexCrown ratings for periods up to the end of December last year, the Global Value Fund of Funds achieved three PlexCrowns and was ranked behind the Allan Gray-Orbis Global Equity Feeder Fund, but only slightly ahead of the Nedgroup Investments Global Equity Fund.
Prudential has one other foreign fund that contributes to its average PlexCrown rating for the management of foreign funds and hence its overall rating.
In the foreign fixed-interest bond sub-category, Prudential’s Global High Yield Bond Funds of Funds scored a relatively high four PlexCrowns over periods up to the five years to the end of December last year. With that score, Prudential obtained an average rating of 3.5 PlexCrowns for the management of foreign funds. Therefore, Prudential was ahead of Nedgroup, with 3.25 PlexCrowns, but was well behind Allan Gray, with five PlexCrowns.
Strengths and weaknesses
The results of PlexCrown’s return-based analysis of the average asset allocation of Prudential’s Equity and Balanced funds over the three years to the end of December last year are outlined in the table (see link at the end of this article).
De Klerk says the composition of the funds is predominantly value-based but not exclusively so. The Equity Fund is reasonably diversified, with exposure to other South African stocks and foreign equities and a relatively high cash holding. This type of investment approach explains why the fund and the investment house tend to out-perform other asset managers in the asset classes where they compete when the domestic equity market is strong or weak.
Due to its diversification into foreign markets and other South African stocks, and a fair amount of liquidity, the downside risk of the Equity Fund is six on the PlexCrown Risk Classification Scale – significantly lower than the sub-category’s average of 7.4.
However, the Balanced Fund’s risk of five is higher than the 4.3 average of the domestic asset allocation prudential variable equity sub-category.
It can therefore be said that Prudential is likely to out-perform its peers in both bull and bear markets, De Klerk says.
CONCLUSION
While the top three managers that were honoured at this year’s Raging Bull Awards all perform consistently well across their suite of funds, they perform better in some areas than in others and, depending on the markets, will fare better or worse in certain asset classes. The right blend of funds should help to ensure that you always enjoy better-than-average returns on your investments.
This article was first published in the 2nd quarter 2011 edition of Personal Finance magazine.