Fund managers with absolute return mandates need to consistently exceed inflation plus outcomes, no matter the market cycle, to deliver certainty and mitigate sequence risk.
Sequence risk refers to the danger of timing withdrawals in a bear market, where investors may sell units in their portfolio which in the long run hurts the performance of their investment. To mitigate this risk, a fund needs to consistently beat inflation comfortably through market cycles, says Amplify Investment Partners head of strategy Richard Bray.
Yet many funds find this difficult to achieve.
Looking at the universe of low, medium and high equity and general equity funds from 2017 to the end of 2020, only 10% of funds managed to achieve CPI + 3%, and over a longer period, 50% of funds at best were able to.
“The great challenge is the lack of inflation-beating returns by funds and fund managers,” says co-portfolio manager of the Amplify SCI* Defensive Balanced Fund and Amplify SCI* Absolute Fund, Lourens Pretorius of Matrix Fund Managers.
“As an asset manager, it is one thing to say you will have a CPI + 3% outcome, but the risk of making a mistake, timing risks, and the risk of consistency in delivering this return should not be underappreciated,” he says.
The Amplify SCI* Defensive Balanced Fund has delivered a CPI + 3.8% annualised return outcome since inception, and it has consistently tracked CPI + 3%, barring the perfect storm in February and March 2020 when there were drawdowns, although those were muted.
Pretorius says the fund aims to deliver this outcome “void of excuses”, in other words, through different economic cycles and market environments, through reliance on managers’ skills and active asset allocation, using different drivers of return in portfolio construction to give them higher certainty they can attain the desired outcome.
Matrix constructed a static portfolio reflecting a typical strategic asset allocation framework, which included roughly 20% money market, 30% SA government bonds, 28% SA equity, 10% offshore equity and 12% fixed income. The Amplify SCI* Defensive Balanced Fund exceeded this portfolio by almost 2% on an annualised basis, which Pretorius says is “meaningful and evidence of value add in terms of return enhancement”.
Managing a portfolio is not only about driving excess returns but also about mitigating and minimising risk, and aside from March 2020, the fund has never, on a rolling 12-month basis, delivered a return that falls short of inflation, while the static allocation has on several occasions, providing evidence of the Amplify fund’s ability to deliver return enhancement and risk mitigation.
To manage an absolute return mandate, the real return objective is the primary goal. “When we construct a portfolio, and when we think of return drivers, we look at how to attain the absolute return with the highest certainty and lowest tail risk, and we tend to veer towards overweight where such a return driver meets the return objective when the distribution of risk around that is acceptable.” This is constantly adjusted through continuous assessment and decision-making.
Low equity, defensive or absolute return mandates, by implication, have a lower equity and larger fixed-income element, typically 35%/65%, or 40%/60%.
While money market real returns have dropped to virtually zero recently, our bond market has repriced, and there is value in it, with 5% real yields in fixed-rate bonds and a percentage lower achievable in inflation-linked bonds.
Local equities are cheap and probably warranting overweight in local equities, says Pretorius. The forward P:E multiple of local equity is 10x and closer to 8.5x excluding Naspers, compared to the US equity market at over 20x and the broad MSCI World Index closer to 20x.
South Africa has been trading at a 20% discount to the S&P 500 through time and currently trades at a discount of almost 50%, three standard deviations from our average, and Pretorius believes that there is not a value trap. The funds’ managers see strong earnings growth next year of close to 20%.
The fund managers expect a marginal real return from money market investments but a strong return on bonds, “making them a relevant investment opportunity and an asset class return driver we would like to be somewhat overweight in.”
The fund has also upped its equity allocation. The equity return expectation, which is higher in local equities than offshore, is earnings and value-driven, and the fund will be overweight local equity.
Over time, the fund has downscaled cash or money market allocation to almost zero as real returns diminished and increased the allocation to bonds with very attractive real yields. As a result, the mix of local and offshore equity has also shifted considerably to local.
Matrix equity portfolio manager Leon Michaelides, a co-portfolio manager on both funds, said equity, particularly domestic equity, presents an attractive risk reward against other asset classes, “particularly given the extreme valuation dislocations in our market compared to offshore”. He says there is “a powerful cocktail” of low valuations and strong and accelerated earnings momentum.
He adds that there are positive macro signs. The rand is appreciating on strong terms of trade that are being sustained, interest rates are low, mortgage growth is recovering, and there are high cash levels at banks, indicating potential spending power of consumers when confidence returns.
Sectors driving growth include insurance, non-mining resources, investment holding companies, retail, real estate and banks. These are prevalent in the fund’s portfolio, with the fund’s managers constantly keeping an eye on any changing trends to ensure the mix is in line with desired investment outcomes.
Amplify SCI* Defensive Balanced Fund
Maximum fund charges include (incl. VAT): Manager initial fee (max.): 0.00; Manager annual fee (max.): 0.92%; Total Expense Ratio (TER): 0.94%. The Manager retains full legal responsibility of the third-party portfolio. The registered name of the fund is Amplify Sanlam Collective Investments Defensive Balanced Fund.
Amplify SCI* Absolute Fund
Maximum fund charges include (incl. VAT): Manager initial fee (max.): 0.00; Manager annual fee (max.): 1.03%; Total Expense Ratio (TER): 1.28%. The Manager retains full legal responsibility of the third-party portfolio. The registered name of the fund is Amplify Sanlam Collective Investments Absolute Fund.
*Sanlam Collective Investments