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The PSG Flexible Fund: equity-like returns at lower levels of risk

26 January 2018

The PSG Flexible Fund: equity-like returns at lower levels of risk

Basic fund information

Fund name: PSG Flexible Fund
Fund size: R12.6 billion
ASISA sector South African - Multi Asset - Flexible
Benchmark: CPI+6%
Managers: Shaun le Roux and Paul Bosman

The fund aims to deliver real (after-inflation) capital growth at low levels of risk

The PSG Flexible Fund has the primary objective of delivering equity-like returns at lower levels of risk. With a focus on first preserving and then growing capital, it uses three core building blocks:

1. Cash

If the market does not present attractive opportunities, we are happy to sit in cash and wait patiently for better prospects.

2. Domestic equity

We seek out the best opportunities for our clients, regardless of size, popularity or index weightings. We routinely look beyond the Top 40.

3. Offshore equity

We have a history of making full use of the equity universe available to us, and have invested directly in offshore equities for over a decade.

Who is the fund appropriate for?

The fund can invest between 0% and 100% in equities, with a maximum of 25% outside South Africa. Historically, equity allocation has varied between 60% and 100%. As such, this fund sits in the upper half of the risk/return spectrum. Its investors should be comfortable with stock market fluctuations and should have an investment horizon of five years or longer.

Asset allocation is based on opportunity

We follow a disciplined process of comparing price to value. Our aim is simple: to buy low and sell high, always taking a long-term view. If we can find many shares that meet our strict investment criteria, the fund will have a higher equity and lower cash exposure. In contrast, when market valuations are high, the fund will increase its cash allocation, as shown in Graph 1.

Generally, the fund holds relatively high levels of cash (represented by the shaded area) – 26.7% on average since 2004. However, when there are attractive buying opportunities, we deploy cash aggressively. This was the case in 2008 to 2009, when general market panic at the height of the financial crisis caused prices of high-quality stocks to fall along with the rest. We pounced on this opportunity and our cash holding decreased significantly.

The graph also reflects typical outcomes of a flexible asset allocation mandate. In a rising equity market where we feel valuations are stretched, a higher cash exposure will mean that we lag the general market. However, when markets are falling, the fund’s drawdown (decline) should be lower. In 2008, for example, the market lost 45%, but the fund only lost 27%. In addition, the fund recovered these losses within 15 months, while the market took 30 months.

A consistent process gets the odds in our favour

Buying low and selling high sounds both intuitive and simple, but it is not that easy when market forces are configured to make you do the opposite. It is difficult to buy low. When quality securities are cheap, it is generally due to a strongly negative narrative. This makes buying them incredibly uncomfortable and often seemingly risky. It is also difficult to sell high, when the popular narrative is overwhelmingly positive and exiting a position creates fear of missing out on further possible returns. Finally, it is not easy to sit in cash for long periods. Over the long term, the real return available from cash does not stack up to other asset classes. However, we view cash as a buffer that allows us to take risk in equity exposures. It also serves as firepower to deploy when the market pitches compelling opportunities.

To buy low and sell high with discipline, we apply our 3 M process to each security we consider for investment. We assess Moat (sustainable competitive advantage), Management and the Margin of Safety (the extent to which a security’s current price is below our estimate of its intrinsic value). This ensures a focus on both quality and price.

A compelling long-term track record

The PSG Flexible Fund has returned 16.7% per year since inception, handsomely outperforming its benchmark of CPI+6% (11.9%). It has beaten the market over all meaningful periods, despite its high average cash holding. This is shown in Table 1.

A flexible fund is suitable for current market conditions

The near-term market and economic outlook is uncertain. This makes it dangerous to position a portfolio for any outcome or political event, and makes short-term decision-making difficult. It is, however, a good environment in which to make long-term decisions, primarily because there is a persistent and wide divergence in valuations between the most expensive and cheapest stocks on the market. Globally, this divergence was last as wide in the ‘dot-com’ era.

Valuations are attractive, and a long-term approach will provide rewards
We believe that if we pick well from the cheaper parts of the market and avoid overvalued stocks, it will position our clients to generate strong long-term returns. This is especially true in the local market, where domestic sentiment is currently as poor as usually measured in times of deep crisis. It is encouraging to note that this has driven certain asset prices down to levels that have produced excellent long-term returns for our clients in the past. The fund’s equity holdings include a number of domestic companies of above-average quality that are trading at very attractive valuation levels. When we combine the current cash holding of 30% (25% locally and 5% offshore) with the favourable returns we expect from the equities we own, we are confident that we will continue to protect and grow client capital over the long term.

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