PortfolioMetrix believes the majority of unit trust assets on platforms in South Africa do not need to be Regulation 28 compliant.
Just a few years ago, it seemed there was an unstoppable flow of money into South African multi-asset high equity funds. These products had become the savings vehicle of choice for local investors, and appeared unlikely that anything would change that.
Something, however, has changed. At the end of 2015, multi-asset high equity funds accounted for 24% of all assets invested in local collective investment schemes, according to the Association for Savings and Investment South Africa (Asisa). By the end of last year, that had fallen to 22%.
The low returns on the JSE have undoubtedly affected how these products are viewed. The steady, inflation-beating returns that many investors expected, didn’t materialise.
A significant question for the local industry now is whether the shift away from these strategies is simply a cyclical response to market dynamics, or whether there is something more structural taking place. Specialist multi-manager PortfolioMetrix believes that while this move is temporary broadly speaking, there is an underlying, longer-term shift that needs to be reckoned with.
Industry evolution
Phil Bradford (pictured), PortfolioMetrix’s head of SA investments, said the single-manager multi-asset offering was becoming ‘dated’.
‘The South African asset management model was built on bottom-up, stockpicking alpha in late 1990s and 2000s during a massive bull run,’ Bradford said. ‘Everything was heavily local equity-centric. We have slowly seen a trickle away from that, but your senior portfolio managers, who have been running funds for years, are typically dyed-in-the-wool bottom-up stockpickers as opposed to asset allocation specialists.’
Local multi-asset portfolios are heavily South African equity-centric. If a manager’s main competency lay in equity research on the JSE, that supported these strategies.
However, when local equity returns dried up, so did overall balanced fund performance. This, said Brandon Zietsman, PortfolioMetrix’s CEO and CIO, ‘highlighted the vulnerability of the model’.
‘Portfolio construction in the multi-asset space is a very specific skill, and that is not necessarily where the single managers have focused,’ he added. ‘We have great single managers in this country, but we compete very effectively with their multi-asset products because we are way more focused on portfolio construction and asset allocation than most single managers.’
Specialists
This is where he sees an industry shift taking place.
‘I think the evolution of this industry is that single managers will increasingly become asset class specialists,’ Citywire + rated Zietsman said. ‘They will expand their market because you have foreign buyers looking for asset managers in South Africa. So, the growth prospects are good. But in the multi-asset space, portfolio construction has become highly specialised.’
This is an area of opportunity, as different skills and a different focus are required.
‘In the specialist multi-manager model, you invest exponentially more in the engineering components, which is your asset allocation,’ Zietsman said. ‘That doesn’t mean that you sit on a static asset allocation. There are times when you have to adjust because of risks, but, by-and-large, the first layer of asset allocation, which is often neglected, is a solid piece of engineering.’
This is also not just a broad principle about diversification.
‘There is a lot of science in it,’ said Zietsman. ‘Not putting all of your eggs in one basket is not real science. It’s a principle. But there is science to how you combine the eggs and making the asset allocation fit for purpose to meet the investor need.’
Investor needs
In particular, PortfolioMetrix believes the industry will see a shift away from a focus on Regulation 28-compliant funds, which don’t necessarily meet investors’ requirements.
‘The vast majority of retail unit trust assets on platforms in South Africa do not actually need to be Regulation 28 compliant,’ Zietsman (pictured above) said. ‘It’s only your preservation and retirement annuity funds that need to be. Yet investors tend to use Regulation 28-compliant funds as the default savings vehicle regardless.’
‘Clients’ objectives are a lot more complex,’ Bradford added. ‘The standard, off-the-shelf Regulation 28-compliant balanced fund doesn’t do the whole job. While the moderate risk is attractive to investors (especially for those drawing an income), the embedded South Africa risk is high. Sound portfolio engineering allows for less concentration in South African assets, while not increasing portfolio risk.
‘We need to be a lot more flexible around what we offer, and what advisers can use. On the back of that comes better investment decision-making as well.’
Exposure
Changing that mindset also changes the asset allocation question.
‘In the pension fund space, because you have to invest in line with Regulation 28, if you want to run a more aggressive portfolio you are forced to take too much South African equity exposure because your offshore equity exposure is capped,’ said Bradford. ‘Whereas, if you are not constrained by Regulation 28 – and not because you have a particular view on South Africa – that just gives you freedom to be more diversified.
‘Not having that freedom has hurt investors for a decade. But if you didn’t need to be invested like that, the best funds available didn’t have that asset allocation flexibility.’
This is where specialist asset allocators could be effective, he said.
‘For example, we have developed products very specifically for the living annuity market where the risk and volatility is similar to a Regulation 28 portfolio, but we’re running offshore exposures of more than 45%,’ Zietsman said.
‘As soon as you start thinking more globally, that whole asset allocation model, where most of it is in South African equity, and that is where you have your core competency is out of the window. That’s where the industry is going to change.’