London Calling

PERSPECTIVE: Reflections from 30 000ft

London. It is a destination that is well known to most South Africans and a place that many have previously, or still do, call home. Geographically it is 'the centre of the world' and would hardly be called an exotic destination by modern standards. Every day, 12 million people journey in via road, rail, underground and increasingly, by foot and bicycle, to help turn the wheels of the UK and global economy.

Paul and I spent the past week in the City where we met a range of partners and service providers who assist us with the delivery of our offshore solutions. There is a growing demand (correctly so in our opinion) from clients for insights into offshore markets and we believe strongly in the need to advise our clients through our own experience – hence the desire to sit face to face with the people who are managing our money and guiding us from an offshore trust and structure perspective. In partnership with the team from Fundhouse, we met with investment managers from a wide range of companies responsible for a number of asset class strategies. In addition, we met with a number of direct equity managers and hedge fund managers.  

High level observations: Markets, asset classes, portfolio construction and general thoughts

·               It may sound obvious, but the global investment market is enormous. We are used to an industry where a few managers dominate and the market is typically driven by a handful of shares. London (and no doubt the other global financial centers like NY, HK, LA, Beijing etc) is awash with global money managers, each managing billions of GBP/ USD, staffed by teams of 100's of investment professionals. For example, two of the managers we met with were Blackrock and Legg Masson who manage a combined $5.2trn of assets! For perspective - the market cap of the entire JSE is $186bn and Coronation manages approximately $40bn.

·               As the SA demand flattens, SA managers are increasingly looking offshore for opportunities. Some have done this successfully - Investec Asset Managers is the best example - but the reality is that they will have to compete with global organizations with established distribution and research teams in most major centers. The potential exists for them to be too stretched.

·               The size of the fixed income market makes the equity market seem like a small aside. However, it is in a very tough place at the moment. Long bond rates (the interest rate the governments have to pay you to lend money to them) in most EU countries are flat to negative. Concerningly, investors continue to expect managers to deliver the same historical returns at the same level of risk. This isn’t possible. (more on alternatives below) 

·               SA is irrelevant. As tough as this is to accept, it became increasingly obvious with each new discussion. Given the array of choices available to managers, there needs to be a very obvious and attractive opportunity to attract a manager to our markets. When they did make an allocation, it is tiny relative to other positions and can be easily substituted/ removed.

·               The scale of the markets results in portfolios with a greater number of positions (shares) than we are used to in SA. Here, the commonly held belief is that a high conviction portfolio with 20-30 stocks is the best way to invest. Offshore, it is not uncommon to have portfolios with in excess of 300 stocks. The thesis is that they get more of the investment calls right than wrong and can eke out incremental gains across the portfolio - resulting in a lower risk, but still successful outcome for investors.

·               There is no single way to get results. We met with growth investors, value investors, hedge fund managers, emerging market managers, fixed income managers and asset allocators. Some managed concentrated portfolios and others very diverse portfolios. Each has a unique approach to the markets and most have been successful. The key is settling on a strategy and following through with this. To quote Ben Graham:

“To invest successfully over a lifetime doesn’t need a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework”

·               The London property market is booming. There are currently 62 cranes involved in large scale construction and the city is transforming into a reflection of the global market place that it is. In my opinion, it runs the risk of losing some of its English charm as each new glass and steel skyscraper replaces a low rise building that has stood for 100's of years. From an investment perspective, we would be reluctant to invest in UK property directly at present – particularly in London. It is difficult to gauge the demand for the property, but there is significant supply at serious prices (think R20m for a 1 bedroomed apartment near the Thames). In addition, UK tax law has made investing in your personal name less attractive.

·         The conundrum for investors continues where yields on both bonds and cash are zero or close to it. This forces cash into equity markets where the dividend yields are more attractive than the cash rates. This anomaly forces equity prices higher, despite the weakness of economies.

·         At the time of writing, Brexit was on the radar but not front of mind. The fund managers we met with expect the UK to remain in the EU. This is in contrast to some of the polls and certainly some mainstream press. It may be a case of them having a bias to this outcome? (Interestingly the most efficient predictors - the bookies currently have the 'Stay' outcome as a 4-1 favorite while the polls are roughly even). The preferred trade we came across is to be long the GBP vs the Euro. Should the referendum favour the 'Leave' camp, there is consensus that there will be a lot of volatility with the currencies under pressure. We continue to favour the USD with this uncertainty.

Conclusions and the impact on our investment strategy

·         After a period of underperformance, we believe emerging markets present some interesting opportunities. We are cognisant of the associated risk and volatility, but feel that the time is right to have some exposure. Currency does need to be taken into account when making these investments as long-term developed market currency strength can assist with the return outcome.

·         The belief that, as an individual, you can manage global investments (or even a portfolio of investments) can be seriously challenged. The universe is very large to cover and to find all opportunities. This trip has reinforced our belief in the relationship we have forged with Fundhouse. Their ability to provide deep, independent insights, due diligence and analysis of the markets adds immense value to our process.

·         Given the downside risks that currently exist, passive investment strategies may suffer, should equity markets come under pressure. We believe that it is an appropriate time to allocate funds to active managers who can seek opportunities outside of the main/ large cap indices and are therefore currently underweight our target passive allocation.

·         Alternatives need to be considered. We are considering hedge fund and absolute return funds as an alternative to long only equity funds. The Ucits (unit trust) structure offshore, with its strong governance overlays, provides investors with some viable alternatives.

·         We believe that alternatives to pure fixed interest investments should be included in a portfolio. There are a number of ‘total return’ type funds that can seek returns in variations of fixed interest investments and have a broader range of alternatives. We are currently including these in our portfolios

·         Despite the concerns around pricing of offshore markets, we believe that the opportunity set continues to justify an overweight offshore position – particularly given SA specific risk.

Finally, I called this piece 'Perspective', primarily for the perspective gained through the work experience. However, while we were abroad, we were reminded of the value and enjoyment of working together – sharing a vision for our business and our clients. It confirmed our belief that the path that we have chosen is the correct one and will give us the platform to add huge value to the lives of others in due course. And, if we can have some fun along the way, even better!