With R226bn under management, low equity (or cautious allocation) funds are the fourth-most popular sector after high equity (balanced) funds, general equity funds and money market funds.
They are conservative funds, but more risky than flexible fixed income. They can have a bias towards growth assets, as up to 40% can be invested in equity and a further 15% in property. And they have the same international asset limit as balanced funds — 30%.
Theoretically, investors should be rewarded for the investment in real assets by returns comfortably ahead of inflation and certainly ahead of low-heartbeat income funds. But in recent years stable funds have struggled to keep up with fixed income only funds.
The leading fund in the sector, Allan Gray Stable, had a pedestrian 6.7% annual return over three years.
This year there were outflows of R7.8bn from the sector, more than any other.
Investors would have done better investing in a single government bond and leaving the money there.
The core audience for stable funds is those people within five years of retirement and in retirement. They cannot afford a capital loss over a rolling one-or two-year period but need protection from inflation.
Most fund managers consider investing offshore as a critical way to compensate for a weak rand, which inevitably fuels inflation. But they constantly need to look at the risk/return trade-off of their investments. Stable funds are not peer group funds — losing less than your competitor isn’t an excuse for destroying value.
The five funds include Allan Gray Stable, which, with about R52bn under management, created the category. There were some highly complex absolute return funds in SA, but Allan Gray set the template for a more easily understood beast. It has a maximum of 40% equity and aims to beat what you get in the bank by 2%. No talk of low volatility or hedging.
It is important to know what you’re buying. Absa Absolute is the least equity-centric of the five, but it is managed by the same team which made Inflation Beater winner of the recent Morningstar award for a cautious allocation fund. Fund manager Eben Mare ran a similar fund at Stanlib, and has a more subtle and sophisticated view of risk than the rest.
Discovery Cautious Balanced is run by the 4Factor team at Investec, which was a Morningstar finalist through its Moderate Balanced fund. As fund manager Chris Freund gets closer to earning his free bus pass, he is handing over some duties to rising star Samantha Hartard. The fund is a good choice for those familiar with Freund’s preoccupation with earnings revisions.
It also shows the advantages of belonging to a large house: Freund and Hartard concentrate mainly on domestic equity selection and draw in expertise for fixed income and asset allocation from other teams.
It is worth noting the arrival of the Laurium Stable fund. It is hard to imagine that founders Gavin Vorwerg and Murray Winckler expected to make the lateral move from glamorous hedge funds to stodgy stable funds. But with R24bn under management, Laurium is a medium-sized player with ambitions to offer products at the appropriate risk level for its broadening client base.
Kagiso Stable has had better performance recently than the others: over three years its 9.1% return is 2.4 percentage points ahead of Allan Gray. It achieved this with minimal overseas exposure, with strong performance of some of its mid-caps and reading the platinum shares right. It’s still a small fund with about R250m under management and should start to appear on more buy lists.
Laurium Stable Prescient Fund
It is not often that a quality investment house sets up a new stable fund, but Laurium did just that in December 2018.
Laurium has R24bn under management and an investment team of 12. The shop was known for its equity-focused hedge funds and long-only funds, but realised that to serve its clients it needs to offer products across the risk spectrum. In March, it launched an even more conservative income fund.
Kim Hubner, Laurium’s head of business development, says there was demand from many high net worth retirees for a more conservative product than the Balanced and Flexible funds, but which still have an equity kicker.
Fund manager JP du Plessis was recruited from Prescient to fill the gap in fixed income expertise. Founders Murray Winckler and Gavin Vorwerg, will handle equity selection. The model asset allocation for the fund is 34% equity, 8% property, 20% cash and 38% bonds. There would typically be 28% in international assets.
It is close to the default in equities, at 33%, under in property at 6%, under in cash at 8% and aggressive in bonds at 41%.
The fund is still in its infancy with about R50m under management but Du Plessis says that is large enough to buy a sensible spread of assets. He says it will be more flexible than the giants of the sector. When it expects the rand to strengthen it will take money back from offshore.
The fund includes most of the main stock picks in Laurium’s equity focused funds, but takes out a few volatile ones. Unlike the Balanced Fund, Growthpoint, Shoprite, Standard Bank and Anglo American are not in the top 10. Du Plessis prefers Investec, Stor-age Property, BHP and Absa. He doesn’t see a high dividend yield as a positive, it could be a value trap.
Cash and bonds offer a good return for little risk: bank NCDs offer 8% plus, some bonds up to 10% with inflation about 4.5%. But he says corporates do not offer good value as the tiny additional yield (spread) doesn’t compensate for the risk.
The fund uses derivatives actively but selectively. It has Put options against the US equity market, and covers about a third of its international assets against a strengthening rand.
Kagiso Stable Fund
Often overlooked, Kagiso Stable has an impressive record. It is probably the only BEE fund manager that is strong in both equities and asset allocation.
Fund manager Gavin Wood says that as a smaller shop it has the scope to look at shares with a market cap below R20bn, where there are a lot of bargains. The fund has used very little of its offshore allowance: barely 2% is in foreign equities.
Stable invests into the Kagiso global portfolio and did well through shares such as JD.com, BrightSphere Investment Group (the former Old Mutual Asset Management US), Altran Technologies and Kinder Morgan, an energy infrastructure group.
Its rand hedge exposure is focused on the platinum sector through Northam and Royal Bafokeng. Wood doesn’t find much worth buying in the SA gold sector. He has some exposure indirectly through African Rainbow Minerals.
Otherwise the fund is dominated by domestic mid-caps. Wood says these shares have limited correlation with the Alsi 40 (they are known as low beta shares.) One way to control risk has been to keep the shares equally weighted when it makes sense.
After Northam, Wood’s biggest share is his former employer, Old Mutual. Wood says the new slimmed-down Africa-only group has not yet been correctly valued. Among his quirkier picks are Tiso Blackstar, owner of this publication, as Wood says the historic competitors such as Media24 and Independent are in trouble.
He also holds Libstar, which makes private-label products for supermarkets and owns the Lancewood dairy brand. It bombed after listing, which gave Wood the chance to top up the holding.
There was good stock selection in Quilter — the former Old Mutual Wealth UK was a winner — as well as the modest holding in Naspers. Mid-cap stalwarts such as Clover, Datatec, AECI and Metair all helped. But Wood also stepped in the bog known as Tongaat Hulett and owned shares in the dismal Delta Property Fund.
The net exposure to equities has increased by three percentage points to 26% since December 2018
The fund has unusually high positions in preference shares and property, both more than 11%, and almost half its 46% in equities are hedged. Most of the property is held through the high-yield Dipula and Fortress A shares.
It has few nominal bonds (2%), though it’s slightly more bullish on inflation-linked bonds (6%).
Discovery Cautious Balanced Fund
The fund is managed by the 4Factor equity team at Investec Asset Management.
Chris Freund, the head of the unit, is the lead manager, with Samantha Hartard overseeing the equity selection.
Cautious Balanced has a limit of 40% in equities, and it has about 45% in bonds. To manage the bond part of the portfolio it makes use of the Investec fixed income team, headed by Peter Kent and Malcolm Charles. For asset allocation, Freund gets help from the London-based global asset allocation team, under Philip Saunders and John Stopford. Global equity assets are sourced through the 4Factor team. Rudi Naumann in Cape Town optimises the international holdings so that they complement the local holdings. There is a bias towards companies operating in Europe and Japan, as well as to Hong Kong listings.
The fund’s bias towards resources shares has helped it to be one of the top performers recently. Contributors have included Africa Palladium Debentures, Anglo American, Anglo American Platinum, BHP, Impala, Sasol and South32. Hartard says the fund held no British American Tobacco when it hit lows last year but started buying as it got to levels not seen since it came close to bankruptcy in 1988. She also believes there will be an opportunity to buy Naspers again (which the fund recently trimmed) as she expects the first-quarter earnings for Tencent to be weak. And she expects fair operational results for MTN, which has been oversold on concerns about regulatory pressure on data prices. The fund initiated a position in AB Inbev as broker earnings revisions are now looking positive.
The fund was hit by declines in Massmart, Mr Price, Pepkor and Truworths over a poor retail reporting season, and heavyweights such as Absa, Aspen, Sanlam and Sappi also hurt. Both Standard Bank and Absa are in the fund’s top 10.
It has a large holding in local bonds (45%) and a more modest 11% in local cash. It has almost no exposure to foreign bonds but 4% in foreign cash, and 2.5% split equally between foreign and local property.
Allan Gray Stable Fund
This has been the most commercially successful of the stable funds and is R53bn strong. This is in spite of its worst loss to date of 6.9% between September and November last year, but with local and foreign equities both weak there were few hiding places.
The fund is not a diluted version of the Balanced Fund as it has just one of the three fund managers in common: CIO Andrew Lapping runs a chunk of both funds, but Leonard Kruger and Mark Dunley-Owen focus on Stable and other low-equity mandates.
It has almost a maximum exposure to equities, with 36% in net equities and a further 7% in hedged equities. It has reduced its local holdings in the first quarter, selling shares in Naspers, Remgro and the banks.
It now has a hefty 27.5% exposure to foreign assets: this has not been easy as its offshore partner, Orbis, has underperformed for several years. Most of its foreign holding is held through the Orbis Global Balanced Fund with a splash of Optimal to dilute the risk.
Kruger says foreign exposure adds diversification to the portfolio and protects investors against potential rand weakness. Dunley-Owen says the fund has had a lower exposure to equities in the past but right now it has found a sufficient number of attractive shares to take a full position.
He says SA shares have performed no better than cash over the past five years, well below the 6% average annual outperformance in the past.
Its property holding is below most peers at 4%, and its bonds are a hefty 28%, though with quite a conservative duration of 2½ years. Its 4% to exposure to African bonds looks unusual but includes issuers such as Standard Bank and MTN. But the 21% portion in money market and bank deposits is primarily held onshore.
Commodities group Glencore is the largest share, while Naspers is second equal in Stable with British American Tobacco on 2.7%. Its top 10 equities overall include China’s NetEase; AbbVie, a US hi-tech pharmaceutical business; Taiwan Semiconductor; and oil giant BP.
Stable considers above-inflation returns its primary objective, with capital preservation secondary. It has never had a rolling 12-month negative return in its 20-year history.
Absa Absolute Fund
Absa has two funds in the low-equity category. Inflation Beater won the 2018 Morningstar award in the cautious allocation category mainly because it was the right fund at the right time, an ultra-conservative fund when nobody was being paid for taking risks.
The Absolute Fund is more like the rest of the low-equity grouping, though not by much. It has a fairly modest long-term goal of CPI plus 4%, a benchmark it beat easily in 2013 and 2015 and has beaten more narrowly over the past 12 months. It is third out of 47 in the category since inception in July 2008.
It is run by Eben Mare, a former head of absolute return funds at Stanlib, and Kanyisa Ntontela, previously with the Perpetua equity team. It is very conservatively positioned, with just 21% in growth assets, 12.3% in domestic and 4.5% in foreign equity, and 4.3% in domestic property.
Barely 11% out of the permissible 30% is invested offshore. The biggest component of the portfolio, at 42.4%, is domestic bonds (fixed and floating), a further 8% in inflation-linked bonds and 21% in the local and international money market. No single equity makes up as much as 1% of the portfolio, and it is an eclectic bunch including Oceana, Shoprite, African Rainbow Capital, Tsogo Sun, Alexander Forbes, Coronation, KAP and TFG. There are also tentative positions in shares such as Combined Motor Holdings.
Mare says he would be happy to increase the exposure to equities once he is confident that value can be unlocked. He is tempted by Sasol but expects the first years of the Lake Charles cracker in the US to hold it back.
He adds that as an absolute return fund, it is not interested in buying beta, or market exposure, and prefers more predictable returns, often from shares which do not behave like the index. The prospects for international shares now look much better. Absa Absolute’s biggest overall holding is logistics property share Equites, and it also holds Fortress B. But Mare is cautious about the prospects for the mainstream office and retail sector.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.