INVESTING
31 May 2019
SAUL MILLER Senior Portfolio Manager, Truffle Asset Management
Managing portfolio risk in an uncertain world
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hen we think of portfolio risk, we are primarily considering two risks: volatility, and the permanent loss of capital. Permanent capital loss arises when the initial assessment of value is incorrect due to one’s assumptions not playing out as expected. Volatility is not the same as capital loss. Although we would not want our long-term returns to be volatile, we are not overly concerned with short-term volatility. In fact, as an active manger we welcome it, as it provides opportunities to purchase investments below intrinsic value. Volatility is a function of the underlying investments and importantly, the correlations between them. The less correlated the individual investments, the lower the volatility of the portfolio. At Truffle, we employ the following four strategies to manage and reduce risk:
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Diversification The well-known way to reduce capital loss and portfolio volatility is most easily done through diversification, by investing in a range of assets that ideally have low correlations.
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High equity exposure Since 1900, equity has outperformed bonds and cash, and more importantly inflation, by a comfortable margin in most countries. From 1900 to 2018, in real terms, global equity delivered 5%, bonds delivered 1.9% and cash produced 0.8% (Dimson, Marsh and Staunton 2018). The problem with equity is its high level of volatility even over relatively long periods of time: the global stock market produced a cumulative negative real return for the 22 years between 1910 and 1931, and
DAVE CHRISTIE Offshore Product Specialist, Ashburton Investments
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any investors wish to get exposure to global equity markets, but some are unable to invest in offshore funds. Consequently, investors lose out on potential returns from top performing offshore opportunities. We are now making investing offshore more accessible through feeder funds. Investing in a feeder fund, such as the recently launched Ashburton Global Leaders ZAR Equity Feeder Fund, means investors get to participate in the offshore markets and get exposure hassle free. Why our fund? The Ashburton Global Leaders ZAR Equity Feeder Fund is the randbased feeder of our highly successful Luxembourg-domiciled, US dollarbased Ashburton Global Leaders Equity Fund (the principal fund).
countries like France, Germany and Japan had negative streaks in excess of 50 years!
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Rigorous valuation process The valuation process is best separated into two sections: the overall market value, and relative valuation of individual shares within the market. Targeting high equity exposure when overall markets are cheap should help raise the odds of improved returns, but it’s not as straightforward as one would hope. Finding a reliable valuation metric for the overall market with reasonable predictive power is problematic. The Shiller PE, which is based on a midcycle earnings estimate, does seem to have some predictability of returns over long periods of time. However, this metric would have kept you out of the market for a significant part of the last 20 years. Valuation on an individual share basis is critical to our process at Truffle. We break up the future returns of shares into three key components: dividend yield, earnings growth and a change in the rating. The sustainable dividend yield is the easiest component to determine as it’s based on the current performance of the company adjusted for any temporary excess or depressed profitability. The most difficult component to determine is future earnings and dividend growth. Ideally, we look for companies with high barriers to entry and good returns on capital. This ensures inflation-beating earnings growth over time. We avoid companies on overly high PEs unless we have conviction regarding significant earnings growth going forward. High PE shares often have overly optimistic growth expectations baked into their valuations. When these expectations are not
delivered, significant capital losses result. It is not easy to determine the extent of sustainable high growth in fast-growing companies or the level of sustainable poor earnings growth in cheap companies. Although we acknowledge our limited ability to forecast, we at least try to avoid the traps many investors fall into when investing in deep value due to their deceptively low PEs or avoiding growth shares that are trading on overly high PEs.
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Portfolio hedging We use derivatives to provide insurance at a portfolio and stock level. The cost of this insurance must be reasonable. We currently have protection on 15% of our balanced portfolio covering the overall market and some individual shares like Naspers. We own Naspers due to its investment in Tencent, a fast-growing diversified technology company, which is the key driver of its value. Tencent is likely to grow its share price in the high teens, a bit below its expected earnings growth of over 20% p.a. However, it currently trades on a forward PE of 32X. Should its growth slow down in the next few years, its high PE ratio could fall significantly and as a result we have purchased protection on a significant portion of our holdings. The world of investing fits more in the world of social science than physical science. While mathematical models and statistics provide some level of rigour to the investment process, these should not be taken at face value. An appreciation of risk requires a qualitative assessment of an investment that cannot be distilled down to a single metric. It requires many years of collective investment experience and a rigorous yet openminded investment process.
Ashburton Global Leaders ZAR Equity Feeder Fund launched
Through this fund, South African spreads, relatively high predictability of investors can access a high-quality, earnings and management and balance concentrated portfolio of up to sheet criteria. Through the careful 25 of the world’s most prominent selection of market-leading stocks international mega cap stocks, such in attractive industries, the principal as Alphabet, Visa, Microsoft and fund aims to deliver sustainably Nestlé. Each stock compounding total returns has a market over the long term. A WELLcapitalisation of Since its inception in DIVERSIFIED over $200bn, a September 2013, the dollarglobal presence based principal fund has PORTFOLIO and is typically a delivered a 7% annualised WITH SOME constituent of a return (to December 2018) OFFSHORE major index such and 11.48% year-to-date (31 as the FTSE or the EXPOSURE CAN March 2019). Considering Dow Jones. the biggest sector exposures, HELP TO PUT Unconstrained the top three are Consumer by traditional AN INVESTOR’S Staples at 28%, followed by benchmarks, the Information Technology at MIND AT EASE principal fund 25% and Healthcare at 14%. invests in industry-leading companies While sector diversification within that are characterised by quality the portfolio is important, the fund also attributes – improving cash return benefits from geographic diversification.
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Of the major geographic holdings, the US makes up the largest portion at 56%, followed by the UK at 14%, Benelux countries (Belgium, the Netherlands and Luxembourg) at 11% and Switzerland at 10%. One of the most appealing features of the feeder fund is that South Africans can access offshore investments without having to utilise their offshore allowance. And it can also be invested in through Tax Free Savings Accounts (TFSA). The fund has a minimum lumpsum investment of R5 000, or R500 by monthly debit order. Although there is no riskfree investment vehicle, a welldiversified portfolio with some offshore exposure can help to put an investor’s mind at ease, knowing they have hedged against domestic market volatility.
