There’s no place like home
Unless of course it’s difficult to find one. This begs the question as it applies to new investment funds offered up by the funds management industry – what drives a new fund launch? You would hope and think that most managed funds are created to meet client needs, but the reality is that this is rarely the main driver.
To ensure a fund’s success in market, at least in a time frame palatable for most managers, it must be commercially viable in terms of getting fund flows from investors and will also need to ‘fit in’. Funds must ideally be able to be categorised into peer groups of funds with similar investment strategies or asset allocations.
The advantage of this is that funds can be measured and compared, which allows funds to be rated by research houses. Advice companies and dealer groups can then use these measurements to develop their recommended lists and, over time, benchmark the funds and rate their performance over the long term.
Ratings and market acceptance are critical for funds to be considered for inclusion on platforms, approved product lists and model portfolios. As a result, most fund managers will launch funds that ideally fit into existing peer groups. To choose a different path, a manager would typically need an extraordinary commitment from a client group to warrant proceeding. This commitment would provide the scale necessary to give comfort to the manager.
What’s good for the goose isn’t always good for the gander
One problem with this aspect of the industry is that many funds in a peer group can look the same, bringing less diversification for investors. Being different is often great for investors, but sometimes not so great for management teams!
When investment managers create funds to fit into a peer group or to maximise fund flow, rather than to meet client needs, investors may not get the funds they require. Although some fund managers are category unaware, our industry is simply not set up to accommodate products that don’t fit in neatly, even if this is what clients need.
We give people what they need, not what they want
We have always maintained this mantra at Allan Gray. It’s an idea that ensures we only launch products or strategies that are in the interest of investors. We do not launch products based on themes, fads or trends in order to grow our assets at the expense of long-term return outcomes of clients.
Let’s look at the simple investment objective of many investors: to beat cash.
This should be a given for just about any strategy that invests in assets deemed riskier than cash. But funds that explicitly aim to beat cash are often more complex than they need to be and use ‘alternative’ strategies such as derivatives, which can introduce additional risk. If these strategies work and the fund delivers on its cash-beating objective, the investor gets what they want. But if these strategies increase risk, the investor doesn’t get what they need. One might ask if the complexity of the products justifies their consideration. Perhaps a topic for another day.
Beating cash doesn’t need to be complicated. A simple structure of starting with a default position of cash and then building some exposure to shares via select companies can achieve the desired result, assuming you invest in the right shares.
It’s easier said than done
All investors strive to ‘Buy low and sell high’, but in practice this is extremely hard to do. The behavioural challenges investors face in doing this consistently are significant. In fact, most investors do the opposite, buying at the top of the market during periods of euphoria when it feels safe to invest and selling at the bottom of the market when attitudes are subdued.
To achieve better returns you need to do the opposite – you need to invest counter-cyclically. Investing in expensive companies hoping they become more expensive has always seemed like madness to us. Investing in companies and markets when they are undervalued should lower your risk of permanent loss because there is arguably less room to fall as you have invested with a margin of safety to fair value.
Following on from such thinking it should be logical that there is better value in these shares and accordingly they have greater capacity to rise in the future. Most importantly though, you increased the chance of protecting yourself from large losses. This strategy does of course assume that you have done your research. If successful, then perhaps you can beat cash returns but with much less volatility than the sharemarket.
In 2011 we launched the Stable Fund with this thinking in mind. We keep it simple by aiming to beat the RBA cash rate over the medium term, by investing in cash and term deposits and blending this with a portfolio of select contrarian shares. This ensures we remain true to our long-term, contrarian approach.
At Allan Gray we are contrarian investors, and we naturally invest counter-cyclically. We only aim to buy shares in the Fund when they represent good value and we reduce the equity exposure when the market rises. You can see in the chart that the Fund’s equity exposure has generally increased as the market falls and decreased as the market rises. You can learn more about the Fund here.
Fund portfolio weightings – share exposure increases as market falls and vice versa
Source: Allan Gray Australia as at 30 April 2019
When we launched the Stable Fund it was not readily accepted by the industry and, arguably, it still isn’t. It did not, and still does not, fit in to a nice neat category that allows for easy comparison. Ironically, its simplicity left it homeless, making it difficult to gain acceptance by the broader market.
What to do?
As the Fund has no peers, it can be hard to determine exactly how it should be used.
We have never prescribed how the Fund should be used, rather we have simply educated clients and advisers on what we are trying to achieve. In our conversations with investors they appear to have used the Fund in one of three ways:
- To control their exposure to equities in a counter-cyclical way
- Where they are concerned about broader markets and are looking for a simple and conservative option
- Where they are looking for an alternative to cash and are happy to tie up their capital for two or three years.
Chris Inifer holds a Bachelor of Business Economics and Finance (RMIT University) and a Postgraduate Diploma (with Distinction) in Financial Planning.