Is it viable to ‘stay in style’ as an asset manager in the SA market? It can feel good to be in fashion, but in the world of investing following trends is very risky. We are social beings who like to fit in and that is why we feel good when we follow the latest styles. In contrast, when it comes to your investments, following the latest trends is fraught with danger. Unlike fashion, which changes on a regular and anticipated seasonal basis, investment market changes are unpredictable. Chasing the past year’s top performer is more likely to undermine your wealth than improve it.

GLOBAL UNCERTAINTY AND RISK AVERSION IS HERE TO STAY
Due to ongoing macroeconomic changes and the impact of a changing global political order, uncertainty is likely to continue. This volatility, coupled with the concentration of the SA market, raises the important question of whether it is viable for active investment managers to focus on staying in style while avoiding material losses for clients and still generating alpha (returns that are greater than the benchmark).

SUCCESSFUL ASSET MANAGERS HAVE GOOD FRAMEWORKS FOR THEIR DECISIONS
They usually refer to this as their investment philosophy and/or investment process. This framework encapsulates how they think about investing. Many investment managers embrace a certain style of investing such as:

• Value investing – finding good assets at very affordable prices.
• Growth investing – investing in assets that may be fairly priced currently, but have significant earnings and growth potential that makes the asset attractive.
• Momentum investing – taking advantage of a new trend based on the belief that it will continue.
• Quality investing – investing in companies with solid business models, management and balance sheets regardless of price.

CAN THE SA MARKET ACCOMMODATE A RIGID APPROACH TO STYLE INVESTING?
Style investing has had some success in the SA market but it is hard to predict and produces excessively positive as well as negative alpha. Value investing has certainly gone through a significantly negative period over the past few years. While value investing as a style has begun to bounce back, what Chart 1 shows is that having a rigid approach to staying in style can create peaks and troughs. Argon Asset Management believes that the SA market’s ability to accommodate a rigid approach to staying in style is limited, for the following reasons:

Investors tend to chase outperformance and shy away from extreme underperformance
Investors are often scared off by periods of underperformance. The ‘lumpiness’ of outperformance of following a rigid approach to style investing – typically followed by significant underperformance – reinforces and magnifies inherent investor behavioural biases. This causes investor performance to underperform the fund performance. This is also known as the investor behaviour gap as it is caused by investors selling out of a fund that underperforms (selling at the bottom) and then buying into another fund that shows outperformance (buying at the top).

John Bogle, founder of US-based investment firm Vanguard, compared returns from the US market over 25 years to the end of 2005, the average equity unit trust fund and the returns that the average investor achieved (as shown in Chart 2).

Unfortunately, most investors undermine their own returns through chopping and changing their investments to chase the latest top performing funds.

If you lose 50% this year, you need to earn 100% next year to make up for the loss
The media and popular investment management awards tend to put even more focus on the past year’s performance and star fund managers. While it is important to acknowledge top performers over specific periods, from an investor point of view, this media attention fuels poor investor behaviour.

Research has shown that it is much better for investors to earn steady incremental returns and benefit from the power of compounding (even if they aren’t the top returns in a category). Being in a top fund for one year and then trying to make up for losses the next year compromises the overall outcome.

The basic maths to support this is that if you lose 50% this year, you need to earn 100% to make up for it next year. A more consistent approach to returns and risk management produces better long-term investor returns.

The degree of concentration in the SA market makes rigid style investing problematic
Concentration risk is inherent to the SA market. When one stock, such as Naspers can make up a large proportion of a benchmark, this introduces significant risk. As shown in Chart 3, it makes up more than 16% of the FTSE/JSE Shareholder Weighted All Share Index (SWIX).

Argon Asset Management believes that if you are given a mandate to outperform a certain benchmark, one is obliged to consider the benchmark. Start with the benchmark holdings and then take considered active positions against this where you find opportunities to outperform. Not considering the benchmark can lead to extremes of out- and underperformance relative to the benchmark simply because of the extent to which one stock can influence the index.

RISK ASSESSMENT MANAGEMENT IS KEY TO MANAGING STYLE
Argon Asset Management constructs its portfolios by always considering the benchmark, and this provides their clients with a valuable form of risk control. They are a multi-product investment house, which means that their philosophy differs slightly across products. A common denominator in the way Argon Asset Management manages all of its products, however, is a firm belief in the power of generating incremental positive returns and exercising disciplined risk control at a portfolio construction level. In this way, reduced investor risk and optimised long-term returns are ensured.

PREDICTABILITY PROVIDES PEACE OF MIND
Argon would rather opt for unexciting yet steady, positive and incremental returns, than expose their clients to unnecessary risk and encourage behavioural biases that undermine clients’ wealth.

1st Floor Colinton House, The Oval
1 Oakdale Road, Newlands, Cape Town
Tel: 021 670 6570
[email protected]
www.argonassetmanagement.co.za