Where to for growth investors now?
I had a fascinating discussion with a potential client a few weeks ago. He had made a lot of money over the years from numerous businesses, and was wanting to slow down a bit. It was not long into the meeting when he made clear his requirements.
It went along the lines of “I do think that the markets are looking expensive at the moment, but that does not change the fact that I am still a high risk investor, and I want to see what you can come up with for an investor like myself. I may be over 60 years old, but I made all my money by taking risk and I am not about to stop just yet.”
It was an interesting mandate to tackle given that growth investors have been so well rewarded in the past few years, and that a lump sum investment always entails timing risk. So what options are out there for a risky old man, or any growth investor with new capital to commit to an investment today?
Multi-asset class flexible
The one sector in the unit trust space where one could go for clues on where to invest with a growth mandate is the Worldwide-Multi Asset-Flexible category. Here managers have the full investment universe to access, and are not limited to domiciles or asset classes or by pension fund regulations. With only R23 billion of the over R1 trillion invested in unit trusts, it is a category often overlooked by investors. Our preference in the category is the Foord Flexible and the Coronation Optimum Growth funds.
According to the May 2014 fact sheet Foord has 65% invested offshore and only 35% invested in South Africa. The bulk of the funds (80%) is invested in equities (55% offshore, 25% SA) and the rest is invested in cash. Coronation is more aggressively positioned with 90% invested offshore and 10% local, with over 85% invested in equities and the rest in cash.
So without restrictions on where to invest, the managers are favouring offshore over local, and equities over the other traditional asset classes. Both funds delivered around 15% return for the year ended May 31 2014, but Foord had a Total Expense Ratio (TER) of 1.7% which is significantly lower than Coronation’s TER of 2.85%. We gave the client both funds with a higher exposure to Foord Flexible.
The graph below shows both funds relative to the JSE Alsi since inception of the Foord fund which is the younger of the two. We continue to use the Coronation fund due to the need for manager diversification, and because past performance is no indicator of future performance. We also use Coronation mainly on asset allocation mandates and are happy with the overall performance. We give Foord the higher weighting because of the cost structure.
Private equity has long been an asset class for the very rich and for institutional investors. It has increasingly opened up to retail investors with companies such as Old Mutual Investment Group (Omigsa) and Momentum bringing out retail products. The Omigsa offering seems to have had the most success in this regard. Its OM Multi Manager Private Equity Fund I has the longest track record having started in May 2006. Since then it has outperformed the Alsi by over 9.5% p.a. net of fees. Subsequent funds (Fund II and the Secondary Fund) have failed to outperform the Alsi since inception, but those funds still have some way to go before underlying investments are exited at which point investors can experience a significant uptick in value.
The long term picture shows that private equity has consistently outperformed listed equity in local and offshore markets. The Yale Endowment fund which has been in the top 1% of institutional funds in the US since the mid 1980s has attributed much of the outperformance relative to the Dow Jones to its private equity exposure. This was echoed in the 2009 annual report where the manager made the following statement “The heavy allocation to nontraditional asset classes stems from their return potential and diversifying power…. Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management. The Endowment’s long time horizon is well suited to exploiting illiquid, less efficient markets”
Omigsa’s Fund III is currently open where the company has made a R600 million tranche available for the retail market. Underlying managers include Old Mutual Private Equity, Actis, Ethos, Capitalworks and the Carlyle Group. Some of the more well known investments in the fund include Reclamation, Consol, Actom, Idwala, Tracker and Tourvest. The fund also has exposure to Sri Lankan Asiri Group of Hospitals, India’s Endurance Technology and Sterling Add Life, as well as investments in Brazil, Singapore, and China.
The attraction of private equity is its low correlation to other growth assets, which is a plus from a risk management perspective. It also gives investors exposures to shares not available on the market. One potential disadvantage for retail investors is that the fund is only available via an endowment structure, and there is a huge penalty for early exit. The product is also a relatively expensive one and as such will not be attractive to cost sensitive investors. We would allocate a maximum 10 – 15% of a client’s portfolio to such an investment given these issues.
John Biccard, the fund manager of the Investec Value Fund, made a comment at a recent manager presentation that made me sit up and listen more attentively. He echoed the client’s comment that the market is expensive, and added that return drivers were looking toppish as well. His comment that got my attention was “when the markets are buying a theme, they are selling something they do not like, which creates opportunities. We have never been this far away from the market as we are now…” The challenge John has with his fund is that he has limited options when he cannot find value in the market. The fund is an equity fund and has to have the bulk of its investments domiciled in South Africa. The fund is highly volatile but we believed that a small exposure could deliver good returns if some of the opportunities John discussed were to play out as expected.
We will go back to the client with a recommendation to increase exposure to dividend yielding shares at some point, but current yields do not support an investment at this stage. Listed property also looks unattractive given the potential for rising interest rates in the coming months.
There are not many growth options looking attractive at this stage, but an exposure to an actively managed flexible fund, an alternative asset class and a high conviction equity fund should deliver decent returns in the years ahead.