Senate Group  The importance of asset allocationin the current low yield environment      René Prinsloo – Portfolio Manage...
René PrinslooPortfolio Manager   8 years’ industry experience   B Sc Hons (Act Sci)   Lecturer at Stellenbosch University ...
Agenda The Importance of Asset Allocation Overview of the Current Low Yield Environment Element Real Income Fund     Impac...
The Importance of Asset Allocation
Asset Allocation: The most important decision?One way of breaking down the performance of a balanced fund:  Asset classes ...
Reasons why AA may be most important1. Law of large numbers                                   6
Law of large numbersIn layman’s terms:   The more (independent) bets I take, the more certain the   combined outcome      ...
Gambling exampleWhich of these two is a better business?                                 Venetian Macao:                  ...
Gambling example With 800 gambling tables, this casino is likely to make a steady profit every night Should experience ver...
Gambling exampleSmall casino example:   Some nights the casino will make a large (compared to what was gambled) profit   a...
Insurance exampleIf you had to provide life insurance to one of these two crowds,which would you choose?As a life insurer:...
Investment exampleConsider the following examples:   A manager of an equity fund who chooses between 100 stocks:       Ass...
Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than   p...
Correlations between asset classes                                                                         100%          A...
Correlations within equity market  Considered all All Share Index constituents that were listed in  2000 (105 in total)  C...
Performance between asset classes is moredifferent than performance within asset classes     In bull markets:        bear ...
Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than   p...
The intuitive reason  Over some periods asset classes give very similar returns      Here stock picking will be of greater...
The intuitive reason  Asset classes, however, rarely have the same volatilitySo if you are looking at both risk and return...
Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than   p...
Value of R100 invested in 1960 in 2012                                         21
What impact could asset allocation have had?                                         22
Asset Allocation: Margin for error is small                                         23
Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than   p...
By way of an example Here we look at the period between June 2002 and June 2012 We consider the return and risk of a stand...
By way of an exampleForeign Equities:->10%-> 12.5%SA Equities: 15%2.5% 40%20%   Cash:   Bonds: 10%2.5%25% 0%   Property: 5...
Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than   p...
Academic studies on the topic  “Determinants of Portfolio Performance” (& follow up), Brinson, Randolph  and Beebower, 198...
Bottom line  When you control the asset allocation:      The choice of how much you invest in equities and      bonds is m...
Overview of the current low    yield environment
Jeleze HattinghPortfolio Manager   M Sc (Cum Laude), CFA, CMT      Business Mathematics and Information      Quantitative ...
SA’s nominal yields back to the 1970s lowsSource: Element Investment Managers Research, I-Net, 8 March 2013               ...
FRA Market no longer expecting rate cutSource: I-Net, Element Investment Managers Research, 8 March 2013                  ...
Foreign Flows – can they continue?                                                                                    Cumu...
SA Debt-to-GDP deteriorating…                                              South Africa: Debt as a % of GDP               ...
And SA also deteriorates against peers“downgrade South Africa and upgrade Malaysia…(SA) appears tohave lost its safe haven...
SA bonds relatively unattractive post FX hedgeSource: UBS Research, 6 March 2013                                          ...
Majority of foreign bond inflows at stronger ZARSource: UBS Research, 6 March 2013                                        ...
Is a repeat of 2012’s performance possible?   Source: Standard Bank Research, March 2013                                  ...
-5%                                                                                -10%                                   ...
Real yields are at record lows in SA                                     13y avg real yield = 3.4%Source: I-Net, Element I...
ILBs: Further potential re-rating limited                                                  Real GDP expectations:         ...
Difficult to beat CPI + 3%-7% targets                                            Real Yields: ILBs vs Property Dual Listed...
“New” CPI + targets  Real yields are abnormally low due to global QE and loose monetary policies       This means that the...
Nominal expected return for equities                                                              Currently 9.5% p.a. for ...
Element Real Income Fund
Performance – Real Income Fund                               Element Real            Benchmark As at 28 February 2013     ...
Real Income: Performance & RiskPerformance Ranking*                              Ranking                    QuartileOver 1...
3 Year Performance to Feb’13: AA Low Equity                                                  Risk-Return for Multi-Asset L...
3 Year Performance to Jan’13: Active Managers           Value/Contrarian style               out of favourSource: Alexande...
3 Year Performance to Feb’09: Active Managers                                                                             ...
Asset Allocation Funds Investment Process                               Balanced Funds   Asset Allocation                 ...
Asset Allocation – Real Income FundAt 28 February 2013
Retailers’ bull run looks unsustainableSource: Reuters, 8 March 2013                                           54
Sun International & Shoprite: Earnings per Share         June Year ends:         2011: SUI (504cps)*, SHP (508cps)        ...
Sun International & Shoprite: Share Prices           Yet Shoprite’s share price is 67% higher than Sun International’s    ...
Further drill down into non-equity holdings     Non-Equity Asset Class             % of Non-Equity   % of Fund     Prefere...
Active management of Foreign Cash           Active management of foreign income is a material differentiator           Lev...
The cyclicality of investor emotions…                           Richemont                           SABMiller             ...
… as applied to the S&P 500 indexSource: Advisor Perspectives Inc., 15 February 2013                                      ...
US markets: The illusion of improvement    Macro Statistic                           October 2007          March 2013    D...
SA Asset classes - 15 year bull markets!           Bond yields down 67%!                                   ALSI up 13 time...
Conclusion         Asset allocation is probably the most important investment decision                Despite poor equity ...
Disclaimer  Element Investment Managers claims compliance with the Global  Investment Performance Standards (GIPS®). The f...
Contacts:Mandates:ian@elementim.co.zaPortfolio Management:rene@elementim.co.zajeleze@elementim.co.zaCC:vanessa@elementim.c...
But can the DM’s negative shift be sustained?Source: Carmen Reinhart, January 2013                                        ...
Globally is the same negative real yield story Source: Inet, Element Investment Managers Research, March 2013             ...
Global debt problems have not gone away!            Reinhart & Rogoff                                               Greece...
Debt-to-GDP world map - 2011                                                                                Asia / EM’s   ...
Our own study Defining the problem:     If I am investing my money for some future period (e.g. 5     years)     And I am ...
Our own study Details:      Looked at 10 balanced funds between 1998 and 2012      These funds were all managed by 10 diff...
Our own studyDetails (continued):   Every shadow fund:       Has completely different stock picking than the balanced     ...
Our own study – 1st example                              73
Our own study – 2nd example                              74
Our own study Findings:     In 10/10 cases the shadow-fund predicted the risk     and return better than the manager’s ins...
Bottom line  It is important to remember that something that happened in the  past is not guaranteed to happen in future  ...
SA now 52nd (144) in Global CompetitivenessThe positives?                             Rank    Highlights long-term structu...
Environmental, Social & Governance (ESG)    ESG research incorporated into investment process since 2001           As per ...
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“Importance of asset allocation in a low yield environment” – Element Investments

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“Importance of asset allocation in a low yield environment” – Element Investments

  1. 1. Senate Group The importance of asset allocationin the current low yield environment René Prinsloo – Portfolio Manager Jeléze Hattingh – Portfolio Manager 14 March 2013
  2. 2. René PrinslooPortfolio Manager 8 years’ industry experience B Sc Hons (Act Sci) Lecturer at Stellenbosch University Glacier, Investment Analyst FFA - Actuary CFA Joined Element in November 2007 Appointed Portfolio Manager in June 2012 2
  3. 3. Agenda The Importance of Asset Allocation Overview of the Current Low Yield Environment Element Real Income Fund Impact of Asset Allocation decisions on Performance Current Asset Allocation Macro factors affecting portfolio positioning 3
  4. 4. The Importance of Asset Allocation
  5. 5. Asset Allocation: The most important decision?One way of breaking down the performance of a balanced fund: Asset classes exposed to over a period (strategic AA) “Asset Allocation” Switches between asset classes over period (tactical AA) Instruments held in portfolio “Stock Picking” Switches between instruments Secondary considerations: Fees, taxes, etc. 5
  6. 6. Reasons why AA may be most important1. Law of large numbers 6
  7. 7. Law of large numbersIn layman’s terms: The more (independent) bets I take, the more certain the combined outcome 7
  8. 8. Gambling exampleWhich of these two is a better business? Venetian Macao: Largest Casino in the world 3400 slot machines 800 gambling tables Golden Valley Casino, Worcester One of the smaller casinos in Sun International’s stable 220 slot machines 6 gambling tables 8
  9. 9. Gambling example With 800 gambling tables, this casino is likely to make a steady profit every night Should experience very little change in profit margin from one night to the next Lots of independent bets => certain outcome 9
  10. 10. Gambling exampleSmall casino example: Some nights the casino will make a large (compared to what was gambled) profit and on other nights a large loss Difficult to say if the casino will make or lose money on any given night 10
  11. 11. Insurance exampleIf you had to provide life insurance to one of these two crowds,which would you choose?As a life insurer: The more people you insure, the less your uncertainty Statistically, this type of outcome has a variance that is proportional to 1 ÷ √n 11
  12. 12. Investment exampleConsider the following examples: A manager of an equity fund who chooses between 100 stocks: Assume 60% of his choices are good He will likely have a steady, consistent outperformance of the benchmark A manager of a balanced fund chooses between 6 asset classes Assume he also makes the right decision 60% of the time Out or under-performance of benchmark likely to vary much moreBottom line: Asset allocation is a choice between fewalternative asset classes, so NB to get choice right 12
  13. 13. Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than performance within asset classes 13
  14. 14. Correlations between asset classes 100% Asset Class Correlations, Monthly, 2000 to 2012 50% SA SA SA Foreign SA Cash Equities Property Bonds Balanced* SA Equities 100% 28% 2% -19% 38% SA Property 28% 100% 61% -3% -18% 0% SA Bonds 2% 61% 100% 13% -30% SA Cash -19% -3% 13% 100% -16% Foreign Balanced* 38% -18% -30% -16% 100% -50% -100% Average Correlation: 6% 14
  15. 15. Correlations within equity market Considered all All Share Index constituents that were listed in 2000 (105 in total) Correlation with the All Share Index: 100% Correlation with Alsi, 2000 to 2012 ANGLO 84% IMPERIAL 51% CITYLDG 40% GFIELDS 36% GROWPNT 26% BHPBILL 78% NASPERS-N- 51% ALTRON 39% FAMBRANDS 35% SHOPRIT 26% IMPLATS 73% PERGRIN 51% MVELA GRP 39% JDGROUP 34% ADCORP 25% 50% AMPLATS 73% SANLAM 51% PINNACLE 39% SUPRGRP 34% FPT 24% SABMILLER 64% ALTRON PP 49% SANTAM 39% PPC 34% SENTULA 23% LONMIN 64% GRINDROD 49% TFG 38% BELL 34% RAINBOW 23% OLDMUTUAL 61% AECI 48% LIBHOLD 38% DISCOVERY 33% SA CORP 23% ARI 60% ILLOVO 47% ASSORE 38% WBHO 32% CERAMIC 23% BARWORLD 60% MMI-HLDGS 46% NEDBANK 38% ALTECH 32% PETMIN 22% NORTHAM 60% CAPSHOP 45% AFROX 37% OMNIA 31% SYCOM 20% 0% SASOL 60% WOOLIES 44% AVI 37% MR PRICE 31% CAPITAL 20% SAPPI 58% ABSA 44% M&RHLD 37% MEDCLIN 30% EOH 20% INVPLC 57% MTNGROUP 44% AFGRI 37% SPURCORP 29% CASHBIL 17% STEINHOFF 56% SUNINT 43% HUDACO 37% PICKNPAY 29% KGMEDIA 16% DATATEC 55% ANGGOLD 43% NAMPAK 37% TRUWTHS 28% HYPROP 16% INVLTD 55% AVENG 42% PSG 37% ASPEN 28% PREMIUM 14% MERAFE 55% REUNERT 41% GROUP5 36% BASREAD 27% OCTODEC 14% -50% BIDVEST 54% BRAIT 41% TRENCOR 36% METAIR 27% HCI 14% STANBANK 52% CLICKS 41% HARMONY 36% DAWN 27% OCEANA 12% RMBH 52% ADVTECH 40% ABIL 36% DRDGOLD 27% KAP 11% FIRSTRAND 51% PALAMIN 40% NETCARE 36% INVICTA 26% BRIMSTN-N- 4% -100% Average: 39%, Max: 84%, Min: 4% 15
  16. 16. Performance between asset classes is moredifferent than performance within asset classes In bull markets: bear markets: Most equities should rise fall Not immediately obvious how other asset classes will perform Decision to be in equities is more avoid equities is more important than which equities to avoid be in 16
  17. 17. Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than performance within asset classes3. Conforms with intuition 17
  18. 18. The intuitive reason Over some periods asset classes give very similar returns Here stock picking will be of greater importance Over other periods asset classes give very different returns Here asset allocation will be more important 18
  19. 19. The intuitive reason Asset classes, however, rarely have the same volatilitySo if you are looking at both risk and returns at the sametime, different asset classes almost always deliver differentoutcomes 19
  20. 20. Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than performance within asset classes3. Conforms with intuition4. Impact of asset allocation decisions can be material 20
  21. 21. Value of R100 invested in 1960 in 2012 21
  22. 22. What impact could asset allocation have had? 22
  23. 23. Asset Allocation: Margin for error is small 23
  24. 24. Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than performance within asset classes3. Conforms with intuition4. Impact of asset allocation decisions can be material5. Illustration by way of a simple example 24
  25. 25. By way of an example Here we look at the period between June 2002 and June 2012 We consider the return and risk of a standard balanced fund over that time, invested as follows: 50% SA Equities 10% SA Property 15% SA Bonds 10% SA Cash 10% Offshore Equities 2.5% Offshore Bonds 2.5% Offshore Cash We use standard benchmarks (e.g. FTSE/JSE All Share Index) to calculate returns We compare this standard balanced fund with what would have been achieved by: Altering the asset allocation Having been able to choose the best manager for a specific asset class 25
  26. 26. By way of an exampleForeign Equities:->10%-> 12.5%SA Equities: 15%2.5% 40%20% Cash: Bonds: 10%2.5%25% 0% Property: 50% ->->->0% Cash: Bonds:10% 20% 12.5% ->-> 60% 0% 20% 5% 0% 0% Foreign Equities: IndexBestBest SA Equities: Index IndexBestBest Cash: Bonds: Index -> Best -> Manager Property: ALSI->->->Manager Cash: Index Best Manager Bonds:Index Worst Worst ->Worst Worst ->Worst WorstManager Worst Best Manager 26
  27. 27. Reasons why AA may be most important1. Law of large numbers2. Performance between asset classes is more different than performance within asset classes3. Conforms with intuition4. Impact of asset allocation decisions can be material5. Illustration by way of a simple example6. Academic studies generally suggest that this is the case 27
  28. 28. Academic studies on the topic “Determinants of Portfolio Performance” (& follow up), Brinson, Randolph and Beebower, 1986 Effectively concluded that Strategic AA explains 94% of all “Total Return Variation”, i.e. short-term performance movements “Does asset allocation policy explain 40, 90 or 100 percent of performance?”, Ibbotson and Kaplan, 2000 Findings: Explains 90% of short-term price movements About 40% of the differences of fund performance over long periods of time can be explained by this It also explains about 100% of the level of fund performance 28
  29. 29. Bottom line When you control the asset allocation: The choice of how much you invest in equities and bonds is more important than choosing a equity manager and a bond manager Make the choice carefully as the outcome can be either very good or bad When your fund manager makes the asset allocation decision: It is important that he gets it right, as it is likely the most important investment decision! So choose balanced fund managers carefully 29
  30. 30. Overview of the current low yield environment
  31. 31. Jeleze HattinghPortfolio Manager M Sc (Cum Laude), CFA, CMT Business Mathematics and Information Quantitative Risk Management 8 years’ experience in financial services Allan Gray Ltd – Fixed Interest Credit Suisse and Deloitte Consulting (UK) – Risk Management Standard Bank (SA) – Risk Management Joined Element in May 2010 Appointed Portfolio Manager in June 2012 31
  32. 32. SA’s nominal yields back to the 1970s lowsSource: Element Investment Managers Research, I-Net, 8 March 2013 32
  33. 33. FRA Market no longer expecting rate cutSource: I-Net, Element Investment Managers Research, 8 March 2013 33
  34. 34. Foreign Flows – can they continue? Cumulative Foreign Flows since Jan 2012 (Rm) vs ALBI YTM 110,000 8.50 3 downgrades, 100,000 still net inflows WGBI 8.30 90,000 announcement 8.10 80,000 70,000 7.90 60,000 7.70 50,000 Foreigners buy Marikana S&P Downgrade 7.50 40,000 Fitch Downgrade R64bn bonds 30,000 7.30 20,000 7.10 WGBI Inclusion 10,000 Q2 CA Deficit Moody’s 6.90 - disappoints downgrade -10,000 6.70 -20,000 6.50 01Jan12 16Jan12 31Jan12 10Jan13 25Jan13 13Aug12 28Aug12 12Oct12 27Oct12 15Feb12 01Mar12 16Mar12 31Mar12 15Apr12 30Apr12 15May12 30May12 14Jun12 29Jun12 09Feb13 24Feb13 14Jul12 29Jul12 12Sep12 27Sep12 11Nov12 26Nov12 11Dec12 26Dec12 Cumulative Foreign Bond Flows Cumulative Foreign Equity Flows ALBI YTMSource: Element Investment Managers Research, I-Net, 28 February 2013 34
  35. 35. SA Debt-to-GDP deteriorating… South Africa: Debt as a % of GDP 65 60 55 50 45 Debt as a % of GDP 40 35 30 25 20 15 10 5 0 Net debt as % of GDP Total debt (net debt + provisions + contingent liabilities) as % of GDPSource: National Treasury, RenCap, Element Investment Managers. Updated 27 February 2013 35
  36. 36. And SA also deteriorates against peers“downgrade South Africa and upgrade Malaysia…(SA) appears tohave lost its safe haven status, as the mining crisis and weak consumercredit threaten the pace of economic growth. Furthermore, the ZAR isunder pressure from twin deficits. The South African market is fullyvalued …we do not think it is too late to sell the market.”Source: National Treasury, 2013 Budget Review. Updated 27 February 2013~ UBS Global EM Strategy Team – 12 March 2013 36
  37. 37. SA bonds relatively unattractive post FX hedgeSource: UBS Research, 6 March 2013 37
  38. 38. Majority of foreign bond inflows at stronger ZARSource: UBS Research, 6 March 2013 38
  39. 39. Is a repeat of 2012’s performance possible? Source: Standard Bank Research, March 2013 39
  40. 40. -5% -10% 0% 5% 10% 15% 20% 25% 30% 35% Mar-01 Jul-01 Nov-01 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Income Return Nov-05 Mar-06 Source: Element Investment Managers, February 2013 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Capital Growth Jul-08 Nov-08 Rolling 12m ALBI TR Decomposition Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Total Return Nov-10 Mar-11 Jul-11 Nov-11 Higher yields = negative capital growth Mar-12 Jul-1240 Nov-12
  41. 41. Real yields are at record lows in SA 13y avg real yield = 3.4%Source: I-Net, Element Investment Managers Research, 8 March 2013. 41
  42. 42. ILBs: Further potential re-rating limited Real GDP expectations: 2013: 2.7% 2014: 3.5% 2015: 3.8%Source: Element Investment Managers, March 2013 42
  43. 43. Difficult to beat CPI + 3%-7% targets Real Yields: ILBs vs Property Dual Listed A-Shares 9.0 Dual Listed Property Shares: 8.5 • A-listed shares with “guaranteed” max 5% SGA 8.0 or CPI distribution growth 7.5 • Income protection via preferred pay out HPA 7.0 DIA structure AWA FFA 6.5 • Real spread pick-up between 5.5% - 7% above gov ILBs 6.0 CPI + 3%-7% will be a difficult target to 5.5 beat in the short to medium-term with 5.0 conventional inflation protection ILBs.Real Yield 4.5 4.0 3.5 ABLSI1 IV019 3.0 IV030 ABLI03 2.5 2.0 R189 FRS46 1.5 R202 1.0 R210 I2025 0.5 R197 R212 0.0 0 2 4 6 8 10 12 14 16 18 -0.5 R211 -1.0 Modified Duration Gov ILBs Element ILB Property A-units Source: Element Investment Managers Research, 8 March 2013. 43
  44. 44. “New” CPI + targets Real yields are abnormally low due to global QE and loose monetary policies This means that the domestic historical real risk free rate of 2% - 2.5% has reduced to below 1% Equities have also re-rated as a result of QE Similarly, projected real returns are around a percentage point lower than long-term averages Implications: A portfolio of assets that returned CPI + x% over the long term is more likely to return CPI + x% - 1% going forward I.e. to get CPI + x% you would now need to take more risk 44
  45. 45. Nominal expected return for equities Currently 9.5% p.a. for 5y in nominal terms I.e. inflation + 3.5% assuming 6% inflationSource: Element Investment Managers Research, February 2013 45
  46. 46. Element Real Income Fund
  47. 47. Performance – Real Income Fund Element Real Benchmark As at 28 February 2013 Relative Income Fund CPI + 3% Annualised since Inception 11.7% 8.6% 3.1% Annualised 10 Year 12.0% 8.6% 3.4% Annualised 7 Year 8.2% 9.3% -1.1% Annualised 5 Year 7.1% 8.9% -1.8% Annualised 3 Year 10.0% 8.2% 1.8% 1 Year 15.1% 8.7% 6.4% YTD 3.1% 1.6% 1.5%Inception (30 November 2002) to 28 February 2013Benchmark CPI + 3%Current Fund Size R309,2m
  48. 48. Real Income: Performance & RiskPerformance Ranking* Ranking QuartileOver 10 years 3/5 3rdOver 7 years 6/7 4thOver 5 years 15/17 4thOver 3 years 11/22 2ndOver 1 year 7/28 1stRisk Stats over 3 years* Ranking QuartileSortino 8/22 2ndSharpe 12/22 3rdMaximum drawdown 2/22 1st*Comparing Real Income Fund to the Multi Asset - Low Equity Funds with a track record for thehistory under review (excludes Fund of Funds)At 28 February 2013
  49. 49. 3 Year Performance to Feb’13: AA Low Equity Risk-Return for Multi-Asset Low Equity Peer Group Data for the 3 years ending February 2013 16% Prudential Inflation Plus 14% Coronation Balanced Defensive Nedgroup Investments Stable Personal Trust Conservative Managed Annualised Return 12% STANLIB Balanced Cautious Old Mutual Real Income JM Busha MET Real Return Portfolio Absa Absolute Old Mutual Stable Growth Element Real Income Momentum Conservative 10% Lion of Africa MET Real Return CPI Plus Grindrod Endurance Absa Inflation Beater 5 MiPlan IP Inflation Plus 3 Atlantic Real Income Investec Cautious Managed Contego B2 MET Protected Income Allan Gray Stable BM: CPI+3% Benchmark: 8% CPI+3% = 8.2% Prescient Income Provider1 6% Old Mutual Capital Builder Allan Gray Optimal 4% 1 2 3 4 5 6 - Bubble size represents relative current Fund size - Includes all funds in ASISA Multi-Asset Low Equity Group (excl. FoF). Risk - Benchmark = CPI+3%. Bubble size is the average Fund size of the Peer Group, with the average Annualised Standard Deviation. (Annualised Standard Deviation)*Comparing Element Real Income Fund to the Multi Asset - Low Equity Funds (excluding FoF)Source: Morningstar Research, Element Investment Managers, March 2013.
  50. 50. 3 Year Performance to Jan’13: Active Managers Value/Contrarian style out of favourSource: Alexander Forbes Asset Consultants, January 2013 50
  51. 51. 3 Year Performance to Feb’09: Active Managers Value/Contrarian style in favour*Note: In August 2009 the company name was changed from Fraters Asset Management to Element Investment Managers.Source: Alexander Forbes Asset Consultants, February 2009 51
  52. 52. Asset Allocation Funds Investment Process Balanced Funds Asset Allocation Equity Income Foreign Income Implementation Allocation FRNs/ Cash Bonds ILBs Property Prefs Security Selection Duration Credit Curve Shape Liquidity 52
  53. 53. Asset Allocation – Real Income FundAt 28 February 2013
  54. 54. Retailers’ bull run looks unsustainableSource: Reuters, 8 March 2013 54
  55. 55. Sun International & Shoprite: Earnings per Share June Year ends: 2011: SUI (504cps)*, SHP (508cps) 2012: SUI (606cps)*, SHP (607cps) 1H13: SUI (720cps)*, SHP (642cps) => both companies earned exactly the same the previous 2 years, with SUI earning 12% more in the last 6 months. * Adjusted HEPS < HEPS in graphSource: I-Net, 12 March 2013 55
  56. 56. Sun International & Shoprite: Share Prices Yet Shoprite’s share price is 67% higher than Sun International’s - despite both companies earning the same for the previous 2 years, and SUI earning more in the last 6months! Material relative valuation differentials = opportunitySource: I-Net, 12 March 2013 56
  57. 57. Further drill down into non-equity holdings Non-Equity Asset Class % of Non-Equity % of Fund Preference Shares 6 4 MMkt incl. Cash 10 6 Floating Rate Notes 36 24 Total Bonds 22 14 Nominal Bonds 8 5 Hedged Foreign Bonds 2 1 Net Long Foreign Bonds 13 8 ILBs 10 6 Listed Property 17 11 Total 100 66At 28 February 2013Holdings for Element Real Income Fund 57
  58. 58. Active management of Foreign Cash Active management of foreign income is a material differentiator Leverage internal knowledge of domestic companies that issue in foreign currencies to enhance yield. Have the option to hedge out currency risk depending on the underlying exposure % of Exposure TRR* of Code Issuer foreign Currency TRR* YTM Maturity Currency ALBI income ABLSJ6 African Bank 7% USD USD 48% 21% 5.3% Jun 16 OLDMUT5 Old Mutual 35% EUR USD 28% 15% 7.8% Perpetual Aquarius AQPAU15 17% USD USD 54% 4% 11.2% Dec 15 Platinum EdconEDCONF614 18% EUR USD 13% 4% 3.9% Jun 14 Holdings Edcon EDC615 9% EUR USD 16% 4% 10.9% Jun 15 Holdings Redefine RIN 14% GBP GBP 27% 3% DY: 10% N/A International 100%* TRR in ZAR, since date of first purchase (not annualised).At 28 February 2013 58
  59. 59. The cyclicality of investor emotions… Richemont SABMiller Retailers Platinum/Gold shares Resources 59
  60. 60. … as applied to the S&P 500 indexSource: Advisor Perspectives Inc., 15 February 2013 60
  61. 61. US markets: The illusion of improvement Macro Statistic October 2007 March 2013 Dow Jones Industrial Average 14164.5 14164.5 Regular Gas Price $2.75 $3.73  GDP Growth +2.5% +1.6%  Americans Unemployed (in Labour Force) 6.7m 13.2m  Americans on Food Stamps 26.9 million 47.69 million  Size of Fed’s Balance Sheet $0.89 trillion $3.01 trillion  US Debt as a Percentage of GDP ~38% 74.2%  US Deficit (LTM) $97 billion $975 billion  Total US Debt Outstanding $9.008 trillion $16.43 trillion  US Household Debt $13.5 trillion $12.87 trillion Labour Force Participation Rate 65.8% 63.6%  Consumer Confidence 99.5 69.6  S&P Rating of the US AAA AA+  VIX 17.5% 14% 10 Year Treasury Yield 4.64% 1.89% USD JPY 117 93  EUR USD 1.4145 1.3050  Gold $748 $1583 NYSE Average LTM Volume (per day) 1.3 billion shares 545 million shares Source: Morgan Stanley, 7 March 2013
  62. 62. SA Asset classes - 15 year bull markets! Bond yields down 67%! ALSI up 13 times!Source: I-Net, 8 March 2013 62
  63. 63. Conclusion Asset allocation is probably the most important investment decision Despite poor equity performance (stock selection) over the last 3 years, the Element Real Income Fund still outperformed due to our Asset Allocation decisions. Global and local equity markets do not look cheap Propped up by low interest rates, fiscal deficits and high asset prices – a combination unlikely to be sustainable We remain cautiously positioned Both within asset allocation and within equities Historical underperformers are trading at levels from where they usually outperform significantly Material relative valuation differentials = opportunity Risks to the downside have increased and are not yet reflected in prices“Probably the biggest unknown is what happens when interestrates normalize… bond markets are so finely priced that the falloutcould be very violent for equities.”~ Ian MacFarlane – BCA Global Asset Allocation – CFA Institute – March 2013 63
  64. 64. Disclaimer Element Investment Managers claims compliance with the Global Investment Performance Standards (GIPS®). The firm includes all portfolios managed by Element Investment Managers. Element Investment Managers is an independent, owner-managed company. It provides discretionary investment management services to retail and institutional clients. Element Investment Managers has been verified for the period: 1 January 2003 to 31 December 2011 Copies of our verification reports are available on request. A complete list and description of our composites is available by contacting Ian Jones at: +27 21 426 1313 or at ian@elementim.co.za 64
  65. 65. Contacts:Mandates:ian@elementim.co.zaPortfolio Management:rene@elementim.co.zajeleze@elementim.co.zaCC:vanessa@elementim.co.za Thank you www.elementim.co.za
  66. 66. But can the DM’s negative shift be sustained?Source: Carmen Reinhart, January 2013 66
  67. 67. Globally is the same negative real yield story Source: Inet, Element Investment Managers Research, March 2013 67
  68. 68. Global debt problems have not gone away! Reinhart & Rogoff Greece target Current risk for 2020! Next big risk 68
  69. 69. Debt-to-GDP world map - 2011 Asia / EM’s improving Dark green shows very low levels of debt, dark red / black shows very high levels of debt. Source: Wikipedia, CIA Fact book. Data till end 2011. 69
  70. 70. Our own study Defining the problem: If I am investing my money for some future period (e.g. 5 years) And I am concerned with both the total return of my investment as well as short term movements (i.e. volatility of my investment) Should I focus more time and energy on “stock picking” or “asset allocation”? 70
  71. 71. Our own study Details: Looked at 10 balanced funds between 1998 and 2012 These funds were all managed by 10 different asset management houses Asset allocation data came from ASISA’s quarterly fund category statistics Performance data came from MoneyMate For every balanced fund: We calculated an “shadow fund” This is a fund with identical asset class exposure But where each asset class is invested in the asset class benchmark E.g. if the balanced fund was 60% invested in its own equities and 40% in its own bonds The shadow fund would be 60% in the Alsi and 40% in the Albi 71
  72. 72. Our own studyDetails (continued): Every shadow fund: Has completely different stock picking than the balanced fund it tracks But the exact same asset allocation By looking at the similarity of outcomes we can judge how important asset allocation was We can compare that to the similarity between the manager’s balanced fund and other funds This will show how important stock picking was 72
  73. 73. Our own study – 1st example 73
  74. 74. Our own study – 2nd example 74
  75. 75. Our own study Findings: In 10/10 cases the shadow-fund predicted the risk and return better than the manager’s instrument selection I.e. in 10 out of 10 cases asset allocation was “more important” than “stock picking” If you focus on both the return as well as the risk of the investment outcome 75
  76. 76. Bottom line It is important to remember that something that happened in the past is not guaranteed to happen in future However we think it is highly likely that asset allocation will continue to be the most important investment decision investors face 76
  77. 77. SA now 52nd (144) in Global CompetitivenessThe positives? Rank Highlights long-term structural trends Auditing standards (1) in SA that will impact SA’s ability to Efficacy of corporate boards (1) compete globally. Protection of minorities (2) Regulation of securities exchange (1) Education: Legal rights index (1) Quality of primary education SA: 132/144, ZIM: 63/144Largely driven by private sector efforts Quality of education systemThe negatives? SA:140/144, ZIM: 30/144 Corruption (110) Burden of government regulation (123) Quality of Maths/Science Business costs: Crime and violence (134) SA: 143/144, ZIM: 50/144 Health: Tuberculosis (143) Life expectancy (133) Source: Co-operation: Labour-employer (144) World Economic Forum Global Competitiveness Report 2012-2013 (Sept 2012) Hiring & firing (143) Pay and productivity (134)Primary responsibility lies with government 77
  78. 78. Environmental, Social & Governance (ESG) ESG research incorporated into investment process since 2001 As per UN PRI (2006), CRISA (2012) Environmental Carbon Disclosure Project (CDP) Signatory investor since 2007 Water research in Mining sector Social Mining Industry Skills, Safety, HIV/AIDS & Silicosis Governance Voting record disclosed since 2001* Voting & Proxy Policy available since 2001* Material board engagements (e.g. Nampak, AngloGold, Gold Fields, Lonmin, Freeworld) We have an independent Advisory Board to guide Responsible Investment* First in SA - www.elementim.co.za/responsible-investment 78

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