27four Makes Right Call on Offshore Returns

[First published in Personal Finance, January 2014]

27FOUR STABLE PRESCIENT FUND OF FUNDS

Raging Bull Award for the Best South African Multi-asset Equity Fund – the top-performing fund on a risk-adjusted basis over five years to December 31, 2014

A fund of funds with a focus on investing across asset classes without taking too much risk won the Raging Bull Award for the top-performing multi-asset fund among those that have a limit on their equity exposure.

The 27four Stable Prescient Fund of Funds is a low-equity multi-asset fund that cannot invest more than 40 percent of its assets in equities, but based on risk-adjusted returns over five years, it has beaten funds with an equity exposure of up to 75 percent.

The 27four Stable Prescient Fund of Funds returned 12.34 percent a year over the five years to the end of December 2014, according to ProfileData, and was ranked sixth in its sub-category on straight performance over this period.

Although its average return over five years was well below that of the top performers in the multi-asset high-equity sub-category – the top performer, the Consilium BCI Flexible Fund, returned 18.5 percent over five years and more than 30 high-equity funds returned more than the 27four fund – the fund had the highest PlexCrown rating of all the South African multi-asset funds excluding the flexible funds.

27four, named for the date of South Africa’s first democratic elections –April 27, 1994 – determines the asset allocation for its multi-asset funds and then selects other managers’ funds in the chosen asset classes.

Nadir Thokan, an investment strategist at 27four, says that, at the end of the five-year period to December 31, 2014, about 19 percent of the fund was invested in South African equities and about 18.5 percent in offshore equities.

It was 27four’s belief that offshore equities would deliver better returns than local equities over the past five years, and, for the entire period, it has had a relatively high exposure to offshore equities (it can have a maximum of 25 percent offshore). This strategy and, in particular, exposure to equities in the United States, paid off for the fund, Thokan says.

For most of the past five years, the South African equity portion of the portfolio was split among three funds: Coronation’s Top 20, the Bateleur Flexible Prescient Fund and Visio’s equity fund, now known as the Visio BCI General Equity Fund. All these funds have consistently out-performed the FTSE/All Share Index, as well as their peer group, and have delivered returns that put them in the top quartile of the performance tables.

In 2010, at the beginning of the five-year period, the JSE indices were dominated by mining shares, but commodity prices were coming under significant strain. 27four saw a lot more value in local industrial shares and chose managers who would favour these shares.

“One of the things we got right was that we sought out managers who would invest in quality shares locally and globally – shares with balance-sheet strength, earnings certainty and a willingness to distribute dividends,” Thokan says.

These shares included the hospital groups, big rand-hedge dual-listed shares, such as South African Breweries (later SABMiller), media company Naspers and cigarette manufacturer British American Tobacco. These high-quality companies were then trading a lot more cheaply than they are today, Thokan says.

He says 27four’s role is to know what each manager’s strengths are and in what part of the market it plays, and in this way it can choose managers that are likely to deliver good performance under the prevailing market conditions.

He says it is very important to “blend” managers so that their investment styles and philosophies complement each other.

27four analyses managers’ holdings in their portfolios to determine their style, and conducts a due diligence to determine what their strengths are and during which part of the market cycle they are likely to perform well.

Thokan says 27four focuses on delivering adequate performance without taking on excessive risk – it does not want good positive returns followed by negative returns. It therefore avoids investing too much in a single share or group of shares if different managers are investing in the same shares, or there is too much overlap in the investments of the different managers.

Recently, the fund replaced its holding in Coronation’s Top 20 Fund with the SIM Local Value Fund. Thokan says Coronation’s Top 20 fund performed really well, but, mid-way through 2014, 27four, like many investors, began to worry that local equities had had a good run and the top 40 shares were looking expensive. 27four decided it would be better to move to a manager that picks value shares instead of staying in expensive large-cap shares. Thokan says 27four’s role as a multi-manager is as much about avoiding what will detract from performance as it is about finding good managers.

The offshore equity allocation in the 27four Stable Prescient Fund of Funds has been in Investec’s Global Franchise Fund, the Franklin Templeton US Small Mid Cap Growth Fund and the 27four Global Equity Fund of Funds.

The 27four Global Equity Fund of Funds invests in different offshore funds, including the Morgan Stanley US Advantage Fund, the Vulcan Value Equity Fund, the Brandes Global Equity Fund, the Coronation Global Emerging Markets Fund, the Blackrock Developed World Index and the Morgan Stanley Global Brands Fund.

Thokan says the offshore portion of the portfolio is biased toward the US, and the prices of US equities have increased significantly recently, resulting in many analysts now saying they are expensive. However, he says this is relative, and although the US equity market is the most expensive it has been since the global financial crisis in 2008, it is not as expensive as it was during the dot.com technology stock boom around 2000.

Currently, markets are trading on headline sentiment, he says, and the US will rally first, while the problems with the euro and emerging markets are well-known. If the US equity market becomes overvalued, 27four will reduce its exposure to this market.

Commenting on the fund’s investments in other asset classes, Thokan says that, at the end of 2014, the 27four Stable Prescient Fund of Funds had no substantial exposure to South African bonds.

The local bond market has been “tricky” for the past three years, he says. Local bonds have become more volatile than local managers are used to as a result of more foreigners investing in them and moving in and out of the market on the back of sentiment about South Africa and emerging markets in general.

Thokan says 27four is not comfortable allocating as much to bonds as other managers, particularly bonds with maturities of 12 years or more. It has found that income funds, with exposure to floating-rate fixed deposits, can deliver bond-like returns with much less risk over the long term. These funds do have some exposure to shorter-term bonds.

At the end of 2014, the fund had 43 percent in local income funds, split between the Coronation Strategic Income Fund and the Nedgroup Flexible Income Fund, which is managed by Abax. Both of these funds are top performers in the South African multi-asset income sub-category.

At the beginning of 2013, the 27four Stable Prescient Fund of Funds had a seven-percent exposure to inflation-linked bonds through the Momentum Inflation-Linked Bond Fund. It has been gradually cutting this back as the developed world faces deflation or low inflation as low commodity and oil prices filter through to lower inflation generally. At the end of December 2014, the fund’s exposure to these bonds was 4.63 percent.

The 27four Stable Prescient Fund of Funds also has exposure to listed property through the Prudential Enhanced SA Property Tracker Fund. This exposure, which has returned more than 20 percent a year over the past five years, was at about eight percent until the end of 2012 and has enhanced the fund’s return over the five-year period.

But, Thokan says, this exposure has gradually been reduced since then, as 27four took profits from the sector, and at the end of 2014, the fund had 4.59 percent in listed property.

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