The medium equity sector has been a no-man’s land. Many pension funds, for example, will offer members a choice between a high equity fund — which can invest up to 75% in equities — and a low equity fund — investing up to 40% — but not a medium equity fund, which can invest between 40% and 60%.
The medium equity category, at R56bn, is only a tenth of the size of the high equity category and a quarter of the size of the low equity category. There has been R1bn of outflows from the medium equity category over the past 12 months.
The sector will be even smaller now that it has been proposed that the big gorilla, the R14bn Coronation Capital Plus, move into the high equity category. One of the reasons for the move is, paradoxically, that high equity funds are allowed to go as low as they like in equity, down to zero if they believe equities are overpriced and there is better value elsewhere. But medium equity funds have a floor of 40%.
Capital Plus, however, will still have subtle differences with other asset funds in the Coronation stable. It will have a 70% limit, not 75%, and clients will be reassured by the General Eisenhower-style stable image of its lead manager Charles de Kock, a world a way from the youthful Karl Leinberger at Balanced Plus, and still further from Neville Chester at Market Plus, with his 1930s movie star looks.
The Association for Savings & Investment SA cannot wind up the medium equity category for being too small. It is by no means the smallest in the SA unit trust industry. And even if there is little generic demand for a balanced fund capped at 60%, there are some excellent funds in the category.
Probably the best all round is Nedgroup Investments Opportunity, run by Omri Thomas at Abax. It pulls a lot of levers and could never be called a dull 60% equity, 40% bond fund. Discovery has a strong Moderate Balanced Fund run by Ninety One’s rising star Samantha Hartard.
This month we look at five funds which are far from bland. Foord Conservative, probably better described as a moderately aggressive fund, is the closest to a high equity fund rebalanced with different asset allocation limits. The combined skills of Dave Foord, William Fraser and Nick Balkin are deployed in this fund.
An unexpected bonus of the medium equity funds is that they have had a higher weighting in bonds than the mainstream balanced funds, which has been a substantially better asset class than SA equities over the past three to five years.
In the past many of these funds would have been classified as targeted, absolute return and real return funds. This was abolished as many investors assumed there was an implicit guarantee, or at least a strong promise, that they would not lose their money. Among the funds that still try to run on an absolute-return basis are from lesser-known medium-sized managers.
Amplify Absolute is run by Matrix, historically a fixed income hedge fund manager which has adapted its hedge fund culture to long-only funds. Its rules from one to 10 are never to lose a client’s money.
Mergence CPI + 4% is run by Brad Preston, who has a strong trading instinct and isn’t afraid to say he will ditch shares when necessary, instead of going down with the ship when prices collapse.
Sasfin has won several awards for its Balanced Fund, in fact quite a conservative fund. When Philip Bradford left to go into the wider financial planning industry, many had expected Errol Shear, who might be even more conservative than De Kock, to take over the fund. Instead Sasfin is playing something of a wild card in Arno Lawrenz. He is a fixed income man when multiasset funds still tend to be run by people with equity backgrounds.
One big-brand fund we did look at was Absa Balanced Fund. The house has some good equity research skills, but possibly its most underrated asset is its alliance with Schroders, which gives it access to a wide range of global products. Much better than trying to run global equities off a spreadsheet in SA.
Absa Balanced Fund
There is no clue in the names, but the Balanced Fund is in the medium equity category while the Absa Managed Fund is in the high equity category. Both funds are run by the Absa multiasset team of Kurt Benn and Greg Kettles.
Benn says that over the past five years, Balanced has been the better performer because of its higher bond component. The fund has 40% in local equities and 22% in international equity. But Benn says on a look-through basis, the equity holding is below the maximum 60%. The global equities are outsourced to UK manager Schroders, and its funds have a portion of cash.
Benn says the international holdings are primarily invested through two Schroders funds which are available as feeder funds, Core Equity and Value (which feeds into the Schroders Global Recovery Fund). He says this provides the optimum blend of growth shares in tech and bombed-out shares in the traditional industrial sector.
The Balanced Fund’s fixed income is concentrated on fixed rate bonds, which make up 22% of the portfolio. There are no floating rate notes and just 1% in preference shares and 2% in cash. But compared to its peers there is an unusually high exposure, of 9%, to global fixed income and property.
Locally, Benn is underweight in resources, which he considers expensive, but he still sees upside in banks. FirstRand (2.3% of the fund) and Standard Bank (2.2%) are the largest and third-largest shares in the fund. MTN was second, also on 2.3%, at the end of June. But Benn says he has taken some profit. Much of the holding was bought below R35 and it has run up to R115.
British American Tobacco (1.8%) and brewer AB InBev (1.9%) have been disappointing as defensive staples shares have lost ground to the sexier tech sector. A gamble which has paid off has been investing in Sasol at about R160 a share. With a stronger oil price, and some self-help improving the balance sheet, it now trades around R220.
Benn says the fund does not have to own a share if it doesn’t like it, no matter how much weight it has in the index. Naspers was only the fifth-largest share in the portfolio on June 30, and that was before it slumped in the wake of the recent Chinese regulatory crackdown.
The fund has two retailers in its top 10 — Woolworths (1.7%) and TFG (1.3%). It has bought more of these periodically when they have been under pressure, to ensure the retail sector gets good representation.
Telkom (1.8%) is a more idiosyncratic holding. Benn says while it is not a great company, there is value to unlock.
Amplify SCI Absolute Fund
The fund is run by Matrix, one of several fund managers started life as hedge fund managers. But it proved uneconomical to remain a dedicated hedge fund house, as its peers found.
Matrix now has a full suite of unit trusts alongside its two hedge funds, in the fixed income and multistrategy category. As well as Absolute, it runs the low-equity Defensive Balanced Fund for Amplify, a division of Sanlam. Matrix has developed an equity management capability since it appointed Leon Michaelides from RMB/Momentum in 2015.
Matrix is now a mid-sized firm with R16.6bn under management and 27 staff members. Founder Lourens Pretorius says the fund has a real return objective as its primary goal. Given a choice, it would have preferred a stable outcome to high — but volatile — returns. It is not peer-group focused and aims for the highest probability of return while reducing tail risk.
Pretorius says active management of bond duration and of offshore exposure are underappreciated levers, while stock selection can be overrated. The fund is 39% invested in local equity and just 8% in foreign equity. It has no exposure to bank senior debt, either fixed or floating, with 27% in nominal government bonds, 7% in inflation linkers and 4% in cash. It has no foreign bonds but 12% in foreign cash — a simple way to express a currency view.
Pretorius says the equity allocation in the Absolute fund is not fixed at 60%; it has been as low as 30%. Michaelides says the five-strong equity team does not try to cover everything but focuses on the best opportunities. It looks almost entirely at the 100 largest shares, as it values liquidity.
He believes SA banks are still particularly good value, as their provisioning has been conservative and they are likely to release capital back to shareholders. But Richemont, for example, has unsustainable earnings, as the rich have spent on luxury goods what they would have spent on travel during Covid.
Amplify Absolute is overweight the SA Inc sector, including retailers and insurance. It also likes the free cash flows available, for now, in the diversified miners.
But Matrix believes that while global trade activity continues to underpin commodity prices a shift from goods to services demand in the developed world could slow down the local recovery.
Foord Conservative Fund
This is a medium equity fund, which will rarely go below 50% in equity. Co-fund manager William Fraser says it is designed for investors with a higher tolerance than those in a stable fund but who are looking for a more absolute-return approach than a balanced fund. Not that demand has been high for this niche. The fund is only now touching R1bn under management after seven years.
The asset allocation can be aggressive. The allocation to money market has been as high as 60% and is now close to an all-time low of 11%. Government bonds barely featured in the fund in June 2015 but two years later they were more than 20% and are now about 26%.
It is a common misconception that Dave Foord calls all the shots at Foord Asset Management. But Fraser and Nick Balkin each run a portion of the fund with full autonomy.
Fraser has the most experience in the bond market. The house did well, focusing almost entirely on the R186 government bond in the middle of the yield curve, but more recently it has bought chunky holdings in R2030, R2035 and R2032.
Each manager can choose their offshore allocation through the two Foord global funds, Global Equity and International.
Foord has been a longtime supporter of the NewGold ETF, which invests directly into gold bullion. It has proved to be a more reliable source of returns for clients than shares in gold miners. The holding is now 4% of the fund, but Fraser says it has been as high as 6%. It is a much more liquid instrument than most gold shares, particularly the second-tier producers.
As a smaller fund, and a midsized local equity manager, Foord does not have to slavishly follow the benchmark. It has about 20% of its equity in mid-caps. Naspers is its largest equity holding, but this is followed by two very different shares which provide diversity — diversified miner BHP and brewer AB InBev. Recently its positions in Omnia and Bidcorp have benefited the fund, while FirstRand and Standard Bank have been under pressure.
Mergence CPI + 4% Prime Fund
Mergence can be considered the most innovative of the BEE fund managers. It has R35bn under management, R5bn in what it calls private markets, primarily infrastructure, the rest in public markets, primarily listed equity and multi-asset funds.
Its CPI + 4 Prime Fund has a somewhat confusing name. It is not promising inflation plus four times the prime interest rate — that would be a ludicrous 30% or so every year, and we would all buy it. In fact, it aims for CPI plus 4%. Prime is the name of the management company which hosts the fund. It is in the medium equity category, but not a standard 60% equity-40% bonds fund. It now has 34% in equity and, out of its 23% in domestic equity, 7.5% is hedged.
The lead fund manager is Brad Preston, who is backed up by Fazila Manjoo and Mohamed Ismail. The fund is 52% in fixed income: 30% in fixed bonds, 10% in inflation linkers and 12% in floating rate notes. It is just 8% in cash and the money market.
Preston says owing to the steepness of the yield curve it makes sense to focus on the middle and long end. He says the asset allocation is determined by the expected relative asset class performances, but the real added value is in trying to determine the macro-cycle in the intermediate term, looking at the global economic regime.
Here the rate of change in global growth and inflation are key variables. And the fund will indulge in some short-term trading.
Preston says global assets look expensive, especially large cap US shares. Though it is permitted to hold 30% offshore, the fund has less than 4% in developed markets (DM) and just over 4% in emerging markets. It has a bias towards less expensive sectors in its DM portfolio.
Preston says SA has benefited from an expansionary global monetary regime which has helped commodities and kept the rand relatively strong. But he questions how long this tailwind can last and sees a much clearer risk-return trade-off in local bonds than equities.
Naspers is the only equity in the top 10 holdings, at 3%. The largest holding, at 5%, is in the SA government bond maturing in 2030 with an 8% coupon.
The equity holdings take a benchmark cognisant approach. But Mergence has made some off-benchmark bets. Some, like Argent and Renergen, have paid off; others, such as Ascendis and Brait, have been flops so far. In the large caps it favours Aspen, the hospital chains, banks, British American Tobacco and the diversified miners.
Sasfin BCI Balanced Fund
This fund is the shop’s medium equity fund, its high equity fund is the Prudential Fund.
Philip Bradford had a good track record at Balanced, winnywing several Morningstar awards, but he left for discretionary fund management, joining Portfolio Metrix.
The new fund manager is Arno Lawrenz. Lawrenz was a fixed income specialist at Sanlam, Coronation and Old Mutual before it merged its fixed income unit with Futuregrowth. After setting up boutique fixed income manager Atlantic, he turned to asset allocation as head of strategy at Ashburton. So he has two of the three core skills needed, bond picking and asset allocation, and he can lean on the Sasfin equity research team for the third leg.
His biggest equity holding is 4.5% in the Satrix Top 40 ETF. Balanced is a fund of funds in all but name, with 15% in the Sasfin Flexible Income Fund, 10% in the Vanguard Total World ETF, 5% in the Sygnia Itrix MSCI World ETF and 3% each in two different Sasfin Global Equity funds. But the strategy is working as the fund is comfortably ahead of its benchmark — the average of the medium equity sector, since inception in 2013, over five and three years and in line over one year.
Lawrenz prefers bank bonds to government bonds. In the fund 8% is invested in a FirstRand bond and 10.5% split between two Absa bonds. He has downweighed local equities from 39% to 24% so far this year. He believes the recovery led by the commodities boom is high risk. There could also be a sell-off if inflation ends up higher. Another factor is whether it is unrest or just general political uncertainty.
Though the fund still has a 4% holding in domestic property, Lawrenz says this was made up of special situations. He believes better returns at lower risk are available from other asset classes.
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