“Oh ye of little faith!”
Now if you’re a believer you might be wondering why I’m mentioning that verse. Truth be told, this verse can also be applied to the world of investing and investments!
For the past two years Allan Gray has been warning of the fact that the South African equity market is overvalued. During this time we’ve had one economy after another collapse with no apparent impact on our local economy.
What’s really been strange is the way how, even with our labour force continually demanding more…and our productivity as a nation falling lower and lower, our share prices continued to climb higher and higher.
Last week, of course, was the first wake up call for local investors.
Now what does all this have to do with faith I hear you ask?
Well, the most demanding investment market to work in by far is the retired investor. The retired investor is someone who relies on their investment for income…so when things go south – aka their money loses value – they’re not happy at all!
Over the past two years I have continually had to caution our pensioners from switching out of their Stable fund investments into better performing funds.
Along the way, a few of our investors lost their faith in Allan Gray, and asked to be moved into more aggressive Allan Gray funds. When Allan Gray took a defensive position (read ‘less equity’) in some of these ‘aggressive’ funds, some asked to switch to other investment companies.
This raised the question of whether these investors should have invested with Allan Gray in the first place. Allan Gray has always had a unique investment philosophy, and you either buy into their way of doing business or you don’t.
(In all fair disclosure I want you to know that we focus our investment business primarily with Allan Gray, so take what I say with a pinch of salt)
In all the time we’ve worked with Allan Gray, never once have they backed down from their investment strategy – never once!
You see, it’s easy to run with the ‘flavour of the day’ investment, but an investment company is only truly tested once their investment approach isn’t yielding the results we’ve come to expect from them. This is what Allan Gray has been going through in the past two years.
So what is Allan Gray’s investment approach?
According to Delphine Govender in the latest Allan Gray quarterly summary (June 2011), Allan Gray believes that the biggest risk when it comes to investing…
is the risk of permanently losing your money!
Sounds obvious right? After all who wants to lose money?
According to Delphine many investors tend to focus on two definitions of risk:
- Risk as being different from an index or benchmark (such as the FTSE/JSE All Share Index)
The risk of volatility
Volatility can be compared to my ex-wife’s temperament.
In the morning she was friendly to me, by afternoon she had started screaming at me. Now you would congratulate me on finally getting her out of my life, and tell me that you hope the next one is more predictable.
But who’s to say that the predictable one won’t meet her “Mr Right” ten years down the road, and leave me in the lurch then?
What I’m trying to say in layman’s terms about volatility as a risk measure, is that while a volatile investment into “Joe’s fish and chips” can seem much more risky than investing into a stable “blue chip” company, volatility does not give an indication of “looming threats” to both businesses.
Allan Gray believes that the best predictor of returns is the price you pay for the investment relative to its intrinsic value and risk
The risk in being different from the benchmark
Basically any share whose returns vary widely from a benchmark are considered to have a ‘high tracking error” and are therefore high risk. Allan Gray feels that this doesn’t make sense at all!
The example given is that of Anglo American which makes up 16, 5% of the FTSE/JSE All Share Index.
You would think that a share which makes up 16, 5% of an index would perform in line with that index wouldn’t you?
Between June 2008 and March 2009, Anglo American fell in value by 70% versus the All Share Index which fell by 40%!
Allan Gray is trying to point out that owning an overpriced share does not offer protection from any downside risk of that share.
So what is risk then?
Allan Gray is of the firm belief that investment risk is not about volatility versus its own average or that of any index, but rather the probability of losing money from an investment.
It’s important to consider the magnitude of any such loss and a measure of this is the “Maximum drawdown” of a fund.
Maximum drawdown refers to the largest peak to trough decline in return over the period.
Another factor to consider is how long an investment takes to bounce back from a decline and this is referred to as “months to recovery”.
So how does Allan Gray counter their definition of risk?
Allan Gray always tries to businesses where the share prices are well below Allan Gray’s assessment of the share’s intrinsic value. If they feel that a share is overpriced then Allan Gray will simply not purchase them…and believe me the South African equity market is currently overpriced!
Allan Gray will invest in shares that are out of favour if these shares offer exceptional value.
So is Allan Gray too conservative?
Allan Gray feels that if being fiercely protective about preserving their client’s capital is conservative, then they will wear that badge.
However, if conservatism is misunderstood as them being afraid to act boldly, then nothing can be further from the truth!
Delphine goes on to say, “At Allan Gray we act with conviction, without fear of being different to the conventional wisdom of the day.”
Believe me, I know this to be true…our clients remind us of this all the time, but last week many of them thanked us!
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Until next time.
The InsuranceFundi Team