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    Seed Weekly - Qui legit, adtendite: Let the reader beware

    This article is rather paradoxical in that I am writing of the need to be circumspect about accepting everything that you read as fact.

    The following email that I received highlights the issue of perspective:

    A biker is riding by the zoo in Washington, DC when he sees a little girl leaning into the lion's cage. Suddenly, the lion grabs her by the collar of her jacket and tries to pull her inside to slaughter her, under the eyes of her screaming parents.

    He jumps off his bike, runs to the cage and hits the lion square on the nose with a powerful punch.

    Whimpering from the pain the lion jumps back, letting go of the girl, and the biker brings the girl to her terrified parents, who thank him endlessly. A reporter has watched the whole event.

    The reporter, addressing the biker says, 'Sir, this was the most gallant and bravest thing I've seen a man do in my whole life.'

    The biker replies, 'Why, it was nothing, really. The lion was behind bars. I just saw this little kid in danger, and acted as I felt right.'

    The reporter says, 'Well, I'll make sure this won't go unnoticed. I'm a journalist, you know, and tomorrow's paper will have this story on the front page. So, what do you do for a living?'

    The biker replies "I'm a U.S. Marine, and a volunteer for the Republican party.”

    The following morning the biker buys the paper and reads, on the front page:


    We can see that the perspective, pet hates and prejudices of a writer are very important, these determine which facts are left in the story, which facts are left out and which facts are emphasised.

    Hindsight bias” is another problem a reader often faces. When writing an article, a writer has all the facts about what happened and why it happened in front of him. In his book “Fooled by Randomness”, Nassim Taleb says that “A more vicious effect of hindsight bias is that those who are very good at predicting the past will think of themselves as very good at predicting the future…”. Whilst looking at the past can help us understand why things happened, the future remains unpredictable so take all predictions with a pinch of salt.

    The last problem that I often have with financial articles as a financial advisor, is that the writer is often expressing an opinion on a very limited set of facts and he does not have to sit with the consequences of “unbundling” a long term plan when he changes his mind a year or two down the line.

    I am the first person to emphasise the importance of reading to broaden your horizons and acquire new knowledge, I do however think that it is important to add a proviso “Qui legit, adtendite: Let the reader beware”.

    Think carefully about what you are reading, think about the writers perspective and why he is writing what he is, and lastly a good rule of thumb is if the writer is making predictions / forecasts about what is going to happen in future, you can probably ignore what he has to say.

    Kind regards,

    Barry Hugo

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    Permalink2016-08-24, 09:26:24, by Mike Email , Leave a comment

    Seed Weekly - Low Volatility Factor Investing

    Equity markets have been characterised by increased volatility in the recent past. Associated with this is the short-term underperformance in the markets, which investors are nervous about especially with more uncertainty going forward.

    Figure 1 below illustrates how market underperformance and increased volatility have historically been associated using the FTSE/JSE All Share Index returns data.

    Figure 1: Rolling 1 Year Return & Rolling 1 Year Standard Deviation of the FTSE/JSE All Share Index in Rand

    Source: Morningstar Direct

    This relationship is in line with the conventional risk-return trade-off principle which basically links, ‘high risk’ to ‘high rewards’. Volatility is a commonly used measure of risk – the more volatile an investment is, the more unpredictable future returns are, and the more likely they will deviate from expected returns.

    My previous article on factor investing (smart beta), highlights certain factors which historically have been deemed to earn a long term equity risk premium. The target of factor investing is to harvest the risk premia through exposure to these factors. One such factor is the Low Volatility factor which by definition captures excess returns from stocks with lower than average volatility, beta, and/or idiosyncratic risk. Excess returns/outperformance from low volatility stocks is quite interesting as it contradicts the conventional risk-return trade-off principle stated above.

    I make use of data from the MSCI All Country World Index as there is limited low volatility data on the local market. The chart below summarises why low volatility outperforms over the long term – simply it is a result of lower drawdowns / limited losses in times of market stress.

    Figure 2: Investment Growth since June 1993 and drawdowns over the same period in USD

    Source: Morningstar Direct

    The long-term outperformance is quite remarkable as it points to the persistence of the low volatility factor, even though the main driver is limited downside. Such a strategy is likely to underperform when the markets are strong, but its strength lies in the period of negative market returns. The market tends to underestimate the frequency, magnitude, duration and impact of market downturns.

    The MSCI low volatility uses two construction methodologies to capture the low volatility premium, minimum-volatility-indices and risk-weighted-indices. Minimum Volatility Indices reflect an empirical portfolio with the lowest forecast volatility using minimum variance optimization. Risk Weighted Indices capture low volatility stocks by weighting based on the inverse of historical variance. The result of this construction is a portfolio of stocks that tends to have more or less similar long-term returns.

    A few behavioural explanations have been suggested to explain the low volatility anomaly. The “lottery effect” is the most common and suggests that people tend to take bets with a small expected loss but a larger expected win, even though the probability of a loss is much higher than the win, and the weighted average of the outcome may be negative – similar to paying a small sum for a potentially large lottery win even though the probability of winning is very small. Investors therefore often overpay for high volatility stocks and underpay for low volatility stocks due to the “irrational” preference for volatile stocks.

    Critics of the volatility factor argue that buying a basket of low volatility stocks may lead to unintended bets on valuation and sectors, because such stocks can be expensive and concentrated in just a few sectors (such as financials). Continued analysis and testing is therefore necessary to optimise the potential benefits of investing in this factor.

    The Seed Balanced Fund currently makes use of the Low Volatility factor as an equity strategy within the fund. Blending this strategy with other uncorrelated strategies forms part of our risk management framework. As a result, the fund has enjoyed diversification benefits, helping to reduce volatility in tough markets.

    Kind regards,

    Tawanda Mushore

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    Permalink2016-08-19, 09:31:51, by Mike Email , Leave a comment

    Seed Weekly - Black Swans & Ugly Ducklings

    The past 12 months have been eventful. Some big events were positive while many others where less so, to say the least. We sometimes refer to these big once-off, unpredicted events as black swan events.

    The most recent black swan was Brexit. Although the topic no longer dominates dinner party conversations, it remains highly relevant as negotiations are ongoing and the outcome still uncertain. What we do know is that following the landmark referendum the value of listed UK properties fell, the Pound depreciated and UK interest rates were dropped to their lowest level in history on the back of renewed growth uncertainty. There were also a few days of panic in which most equity markets across the world were sold down, however most have since recovered.

    On the day the results were announced you either owned assets, such as London property or the Pound, or you didn't. If you held these on the day you would have suffered a loss which has not recovered much of its value since. Nothing you did after the fact could change this. Panicked selling or emotional reactions following Brexit would most likely have exacerbated your headache.

    South Africa experienced its own black swan event in December last year when our finance minister was replaced without reason or forewarning, twice. It caused the value of the Rand to plummet and government bond yields to spike. Some panicked and decided to sell their Rands after the sudden drop when the value was at a historic weak point. Since then, the Rand actually strengthened against most developed market currencies, and many who made the decision to sell the Rand immediately after the tumultuous 3 days in December can chalk up the loss to a sub-optimal, panicked decision.

    Of course we aren't, for the purposes of this article, considering the merits of investing in hard currency or even touching on the topic of how much hard currency one should hold. We are just looking purely at the decision to sell an asset following a black swan event and the loss suffered because of this.
    Not all black swan events are negative. Every SAB shareholder will forever remember the day the merger with ABInbev was announced and the share price shot up by +- 27% in one day. The story is similar to the above negative black swan events, either you owned the asset on the day and made a huge profit or you didn't. What made the SAB black swan event different, was the fact that since the announcement of the merger the Rand share price has in fact increased, although it came with significant downside risk if the deal didn't go through.

    Before the announcement of the merger there wasn't much excitement about SAB. The share was expensive and trading within a band. It was by no means a bad company to invest into as it was profitable and generating cash, but nothing really ground-breaking was going on to get investors excited. The proverbial ugly duckling matured into a graceful white swan.

    Events such as these, whether positive or negative, will always be a part of investing. It undoubtedly changes the fundamentals and outlook, and you should always look to re-evaluate your positions based on the revised outlook. Take a deep breath, and make the calculation whether holding onto the asset is worthwhile despite the recent shock, and if the asset is trading at fair value. When making decisions in a fit of panic, you will almost always find yourself looking back to discover an even bigger negative effect. It is as hard as it is simple - accept what happened as a sunk cost and move on.

    Kind regards,

    Stefan Keeve

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    Permalink2016-08-10, 09:58:54, by Mike Email , Leave a comment

    Seed Weekly - Targeting Returns

    In this third article on targeting returns I am going to focus on a very topical subject, not only now but one that has been on the agenda for the entire 25 years I have been in the investment industry.

    There are many views, themes, strategies and methodologies for evaluating the topic and I am not going to try and pitch one over the other but rather focus on a few big picture ideas.

    The question has been and is, should a South African (asset resident) long term investor invest internationally to get better returns from their portfolio? If the answer is yes the second question is if you were unrestricted what percentage of your investable assets should or would you invest outside of South Africa?

    For most South African citizens their biggest assets are all in South Africa namely, their businesses, pension funds and homes. Apart from pension funds that can have up 25% offshore pretty much everything is in South Africa.

    Below is a chart that illustrates the various sizes of the listed equity markets. You will note that Africa makes up about 1.5% and of this South Africa less than 1%.

    Source: The Money Project 2 August 2016

    It does seem quite obvious that South African investment managers would ideally like the opportunity to invest in the other 99% of the global listed equity economy.

    I have read for many years that it is much better to have a decent portion of your investment offshore and remember the early days of exchange control when R250k once off was officially allowed offshore, this slowly crept up and up until recently when it was announced that an individual can take up to R10/11m p.a. offshore. This effectively now removes all exchange control for 99% of the population.

    Without making the ever present political call, let’s investigate the historical facts based on an investment made in Rands. I have chosen several well-known indexes to represent various equity investment options to illustrate the point. The ALSI for the SA market, the S&P 500 for the broader US market, the FTSE 100 for the UK, the MSCI All World for the broad global market and MSCI Emerging Markets Index. I have also used rolling five year returns to reduce the volatility and to illustrate a more strategic allocation by an investor. Just a reminder the returns p.a. are in Rands.

    Source: ZephyrStyleAdvisor 3 August 2016

    So with perfect hindsight history shows us that choosing to go offshore was not straightforward and in fact you would have been a net loser until about seven to five years ago. Also the out performance of the local market was extreme for the better part of this reporting period.
    If you got your timing right to switch offshore immediately after great financial recession of 2008/9 then you have done very well over rolling 5 year periods since by overweighting to the S&P 500, MSCI AW and the FTSE 100 vs. the ALSI.
    Granted I have only used one asset class to explore the question but the same is largely true of most other asset classes. What is very apparent to me is that you need to tactically time your diversification to benefit fully from diversification.
    What is encouraging is that at Seed we have analysed our past performances and have consistently added value through our tactical asset allocation decisions.

    Kind regards,

    Robert Foster

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    Permalink2016-08-04, 16:17:26, by Mike Email , Leave a comment

    Seed Weekly - Currency Valuation

    An important part of Seed’s multi management process is performing monthly asset class valuations using our in-house quantitative models. This process covers all of the local and global asset classes that are suitable for inclusion in our multi asset class funds and model portfolios. The output of these models guide our tactical asset allocation decisions, where we under- or overweight certain asset classes in the short term, compared to our longer term target weights.

    When evaluating global asset classes for our funds, we try to separate the currency decision from the underlying asset class valuation. Practically, this means that if global equities show a lot of value, we might allocate even when the rand is weak. Although currency volatility might overshadow our asset class decisions in the short term, investing at attractive valuations pays off over the long term.

    We look at both the trend exchange rate of the Trade Weighted Basket of currencies and the well-known Purchasing Power Parity (PPP) relationship against each of the majors on a monthly basis.

    The Trade Weighted exchange rate of the rand is based on trade in and consumption of manufactured goods between South Africa and its most important trading partners, incorporating twenty different currencies. Presently, the five major currencies in the basket are the Euro (29%), Chinese yuan (20%), US dollar (14%), Japanese yen (6%) and British pound (6%).

    The graph below illustrates that the rand is around 20% undervalued given the long term trend in the Trade Weighted basket of currencies:

    Source: Seed Investments 26 July 2016

    The PPP relationship is based on the law of one price, meaning a consumer should be able to pay the same price for a diversified basket of goods, no matter in which economy the purchase is made. In SA, with local annual inflation running at 6.1%, a consumer will see his purchasing power eroded a lot quicker than in the US, where inflation is 1.0%. Therefore, a SA consumer needs to be “rewarded” with more rand per US dollar each year - resulting in rand depreciation - if this relationship holds.

    Theoretically, PPP implies that SA’s 5% higher inflation should result in around 5% depreciation per annum against the dollar. In practice, actual exchange rates can deviate from the calculated PPP estimate for extended periods. Over the last 10 years, SA inflation has been running at 6.3%, with US inflation at 1.8%, while the rand has weakened by 7.5%, quite a bit more than the expected 4.5%.

    The graph below illustrates that, at a market rate of R 14.70 as at end June, the rand is around 37% undervalued vs. the calculated PPP rate of R 10.69.

    Source: Seed Investments 26 June 2016

    In the wake of the Nenegate sage in December last year, the rand has been exceptionally volatile, prompting many investors to re-evaluate their global exposure. At Seed, we have not traded on the short term volatility, but have maintained our global allocations at close to 25% for our multi asset class funds and model portfolios.

    Kind regards,

    Cor van Deventer

    ***SEED IS HIRING: Click here to view vacancy

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    Permalink2016-07-27, 09:15:01, by Mike Email , Leave a comment

    Seed Weekly - Investment Strategy in a Negative Interest Rate Environment

    My last article discussed various investment manager styles. Included here were styles such as top down, value, contrarian, growth, quality, momentum etc.

    In this article, we explore possible investment strategies and some specific reasons why investors would be explicitly “investing” cash at a negative nominal interest rate, i.e. investing with the guarantee of receiving back less in nominal terms after a defined period of time. Because such an investment approach goes against our normal understanding of investments, it is difficult to believe that an estimated amount of over $10 trillion is already invested into negative yielding assets in the form of mostly government but also corporate bonds.

    As an example, last week it was reported that the German Bundesbank issued €4 billion, 10 year bonds at a yield of negative 0.05% p.a. yield. In this instance investors were prepared to part with a substantial sum of money, with the explicit promise that they would receive a haircut of 0.05% each year off their initial capital invested.

    This is a classic case of investors being so risk averse that they are more concerned with the return of their capital than their return on capital.

    So let’s look at some reasons why investors would adopt this as part of their overall investment strategy.

    One investment approach adopted by many pension funds is the matching of their liabilities with assets. This is known as LDI or liability driven investment. This is an investment style that is focused on the liability side of pension funds. It is mostly defined pension funds that will look to adopt this strategy because they have a defined liability in the form of a promise to their retired employees, which can be actuarially calculated on a year by year basis.

    In order to immunize this liability, pension funds will set aside a portion of the portfolio investments, investing into lower risk bonds. This worked well when bonds yielded higher rates, but many pension funds continue to invest even as yields drift lower into negative territory. It can be justified if, due to deflation, the pension funds liability is decreasing.

    Another buyer of “lower risk” government bonds are insurance companies. Due to increased capital structure regulation, insurance companies own increasingly greater amounts of “less risky” assets. In the past and in order to match their long term liabilities they are “forced” buyers of government bonds.

    Therefore, yields are low and governments are able to issue bonds at these low yields and even negative yields, because there is huge demand.

    • There is demand from risk averse pension funds.

    • There is demand from central banks that are buying bonds issued by government treasuries as a form of quantitative easing.

    • There is demand from the risk averse global savings market, which is generally running higher than new issuance. Because of high demand, governments issuing are able to price yields at lower and lower levels.

    • Another reason is that global investment managers manage according to benchmarks. Where global bonds make up a portion of the benchmark, the decision to not allocate to bonds, becomes a “risky” investment decision, relative to the benchmark and peers. This becomes especially pronounced where the return on bonds has done well. Therefore despite the low and negative yields, investment funds are “forced” to buy bonds.

    According to global bond manager, Pimco, low and negative yields can be pointing to a sharp economic downturn, i.e. a deflationary environment. In this instance investors buying negative yields bonds may still receive a positive real yield, where inflation turns to deflation. For example the real return on a negative 0.05% coupon can translate into a positive 1%, where there is deflation of 1.05%.

    The Economist has called this “slow suffocation” because given the preponderance of negative interest rates, banks and other financial services firms’ profitability will ultimately be hit hard. Not only that but virtually all other investment assets are priced off global bond yields, by adding a relevant risk premium. It therefore makes a difference to all global investment assets, when the starting position is a negative.

    The chart below reflects the steady increase of global funds now invested into negative interest yielding bonds.

    Chart 1: The pool of global negative yielding debt is climbing

    Source: The Wall Street Journal 18 June 2016

    So while there may be lots of reasons why investors, mostly institutional type investors have lots of reasons to “invest” into negative yielding bonds, they are not necessarily making rational investment decisions.


    Ian de Lange

    Seed is Hiring: We are looking for an Investment Business Analyst/Developer to join our Investment Team, click here to view vacancy

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    Permalink2016-07-20, 09:45:28, by Mike Email , Leave a comment

    Seed Weekly - Reviewing our TAA Decisions

    My previous articles focused on how Seed constructs our Funds around predetermined Strategic Asset Allocations (SAA) (click here) and then how we seek to add value through our Tactical Asset Allocation (TAA) process (click here). This week I take this line of discussion to its logical conclusion. Has our decision making added to, or detracted from, performance? Essentially how has our TAA process contributed to returns?

    At the risk of repeating myself, our investment process seeks to incrementally add value to our Funds, rather than risking the fortunes of the entire Fund on one or two outsized allocations. We believe that we have a process that, over time, will produce more good decisions than bad, and we therefore seek to make as many independent decisions as possible so that the law of averages works in our favour and we generate consistent outperformance. Unfortunately in the real world we aren’t always going to get it right, but it doesn’t stop us from constantly striving for this goal.

    Importantly, we have set up systems to analyse the decisions that we have made that allows us to focus our attention where required. The chart below is one of the outputs that we review on a monthly basis. It looks quite busy, but essentially tracks whether the allocation to each asset class has added to (above the 0% line – overweight an outperforming asset class or underweight an underperforming asset class), or detracted from (below the 0% line – overweight an underperforming asset class or underweight an outperforming asset class), the Seed Balanced Fund’s returns on a monthly basis. The total contribution from our TAA is represented by the black dot. This is the granular level at which we make (and then analyse) our asset allocation decisions. The chart tracks the monthly contributions over the past 4 years.

    It is evident that on a monthly basis the return drivers are quite random, with big contributors in one month often being large detractors in the following month. On a monthly basis our TAA process has added value just less than 70% of the time. When extending this analysis to a rolling 12 month view we get a better idea of how our TAA adds to the investment performance. The chart below breaks down our TAA decisions over rolling 12 month periods. Essentially our TAA decisions have added between 1% and 4.4% over any rolling 12 month period over the past 4 years.

    An obvious detractor over the last couple years has been from our underweight Global Bond allocation. Since the inception of the Seed Balanced Fund we have maintained an underweight allocation to this asset class as our research indicates that investors should expect poor returns over the long term. In order to mitigate this position to a certain extent we have overweight allocations to Global Property and Global Alternative. When viewing the underweight Global Bond in conjunction with the overweight Global Property and Global Alternative allocation, it is evident that, in general, this has been a good decision over time (only mildly detracting from returns over the past 4 rolling 12 month periods). The chart below isolates this TAA decision.

    Without going further into the detail I’ll stop this analysis here. Suffice to say that an important part of our investment process is a thorough regular review of the decisions we make. Where they have added to performance we ask whether we should be taking profit or retaining the position. Conversely, where returns have been negatively impacted, we critically assess the investment case again. If the investment case has changed we will not hesitate to cut our losses, but where we are convinced that the investment case has strengthened we are happy to make a higher conviction allocation.

    Take care,

    Mike Browne

    Tel +27 21 914 4966
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    Permalink2016-07-13, 09:19:46, by Mike Email , Leave a comment

    Seed Weekly - Peer Groups acting as Benchmarks

    The age old discussion surrounding benchmarks will carry on for as long as humans occupy this planet and have money available to invest. Are benchmarks set too low, making them very easy to beat? Are they set too high, making them hard to beat unless fund managers take on excessive risks? Is the frequency of assessment against the benchmark appropriate? In this weekly article we will be focusing on using peer groups as benchmarks and how they can add value to our investors.

    The importance of peer groups can be argued endlessly. There will always be investors and investment managers who will argue that peer groups do not meet the complete investable benchmark criteria. Others will argue that we really do not know who has succeeded or failed because success against one peer group can easily be failure against another comparable peer group, so a manager can be both a success and a failure. Another possible disadvantage of peer groups is that they can mislead investors rather than inform them. The sell side knows how to deal with these problems: use the peer group that makes them look best and it’s the buy side (the investor) that suffers most from the problems with peer groups. Furthermore, the compensation of the fund manager typically depends solely on the value of assets under management, as more managers are moving away from a performance fee structure. Therefore, a fund manager’s bread and butter is not dependent on the value added by the fund manager, as there is typically no reward for outperforming the peer group benchmark and no penalty for underperforming these benchmarks.

    Our view at Seed Investments is that although peer groups are not the perfect benchmark (if there is even such a thing as a perfect benchmark), peer groups have their place under the “benchmark sun”. Some asset managers take the position that they are going to disregard what other institutions are doing, and simply follow their own vision. This attitude ignores what may well be the best thinking on the topic. Some examples of herd behaviour in investing may exist, but in general, any sound asset manager takes their responsibilities seriously and is highly capable. These professionals have, as their responsibility, the task of thinking about what asset mix is best for their funds and then implementing it.

    We believe in what we do, but every now and then we need to measure our performance against our peers to ensure that we have not wandered off and lost the plot completely. While it is good to follow your own ideas and dreams, it is important to respect the conclusions of generally well-informed and well-meaning peers. This does not mean you should not vary from the allocations of your peer group if your mandate or risk tolerance is different from theirs, but you will get in real trouble by thinking you don’t have peers when you most definitely do. Consequently, the long-term success of any fund management house in some way depends on its relative performance against its peer group.

    At Seed Investments, we make use of peer groups as benchmarks across the range of our products. Below is a risk adjusted return graph of the Seed Balanced fund compared to the ASISA South African Multi Asset High Equity peer group. The graph illustrates that the Seed Balanced fund has achieved a higher return than the peer group average albeit at taking on a little more risk (standard deviation).

    Figure 1: Risk Reward (Time period 01/07/2010 – 31/05/2016)

    Source: Morningstar 29 June 2016

    This is one of the graphs we use to compare our performance to the peer group. Seed will always, to the best of our ability and knowledge, use the most relevant peer group to compare our funds against. This will ensure that we keep track of our own progress without losing touch with our peer group and will give our clients peace of mind that they can compare our funds with the appropriate funds in the industry.

    Kind regards,

    Stephan van der Merwe

    Tel +27 21 914 4966
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    Email info@seedinvestments.co.za

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    Permalink2016-07-06, 08:56:27, by Mike Email , Leave a comment

    Seed Weekly - Smart Beta – The Art of Factor Investing

    The passive versus active debate has raged on and evolved over the years. More investors are embracing passive investment strategies as they realise the benefits of such strategies over the long-term, both in performance and cost. I highlighted in my previous article that there is a place for both active and passive investments in constructing portfolios.

    As a multi-manager, we look for the best solutions to ensure we meet our clients’ investment objectives and this at times involves blending active and passive management products. In this article, I delve into the intelligently named Smart Beta products (also known as factor investing) which are a form of passive investments.

    The name Smart Beta was coined in the 1990s, although factor investing as a strategy has been in use since the 1970s. Smart Beta is considered an intersection of active and passive management as it combines characteristics of both methods through the focus on specific factors. A factor can be thought of as any characteristic relating a group of securities that is important in explaining their returns and risk. Popular fundamental factors include Value, Momentum, Quality and Low Volatility (shown in Figure 1 below).

    Figure 1: MSCI Factor indices investment growth since January 1997 (in USD)

    Source: Morningstar Direct

    Smart beta strategies attempt to deliver a better risk and return trade-off than conventional market capitalization based indices. In Figure 1 above, the factors have delivered better investment growth relative to the MSCI All Country World Index (MSCI ACWI) since January 1997 to May 2016. Empirical studies show that historically, factors exhibit excess returns above the market. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. Therefore, they diverge from the traditional market indices by focusing on only the area of the market that offers an opportunity for exploitation. In the same way that an active manager filters for Value or Momentum stocks for example, Smart Beta does the same.

    Table 1: Fundamental factors commonly used

    Source: Seed Investments

    The table above lists some commonly used fundamental factors and the areas of the market that they focus on to extract excess returns. This gives an idea to the link between Smart Beta and what active managers are doing. The good active managers however should have the additional stock picking ability and specific fundamental research to generate alpha.

    Figure 2: MSCI Factor indices risk and returns characteristics since January 1997 in USD

    Source: Morningstar Direct

    It is important to note that these factors go in and out of favour at different times, so one cannot expect one factor to outperform all the time. The chart above shows that over the period January 1997 – May 2016, the Momentum factor has been the clear outperformer but also with the highest volatility. All the factors outperformed the MSCI ACWI, both on an absolute and risk-adjusted basis. A blend of the four factors above (equally weighted) results in fairly decent returns and more importantly, reduced volatility. Therefore, since factors move in and out of favour, there is a case for blending factors in managing risk.

    At Seed, we like the idea of Smart Beta and recognise the potential benefits of such a strategy in a portfolio. The Seed Balanced Fund makes use of the Low Volatility factor as a strategy within the fund. This strategy is blended with other uncorrelated strategies to ensure that we get the diversification benefits and risk management from both passive and active investment management.

    Kind regards,

    Tawanda Mushore

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2016-06-29, 09:03:48, by Mike Email , Leave a comment

    Seed Weekly - The Look-Back Folly

    Looking back and reflecting is essential to the human experience. You can learn much from your preparation for and reaction to past events and mistakes in an effort to better yourself. This is crucial to the investment process, but herein lays both opportunity and danger.

    Looking back may lead to naïve extrapolation of past results into future expectations. Although this may sound condescending it is by no means the intent, it happens to the best of us. While price momentum undoubtedly exists and is a valid input in the investment decision making process, it relies on a couple of underlying factors that do not necessarily work in isolation. It is deceptively easy to assume that because a certain company or asset class produced good recent returns it will continue going forward (or vice versa) without due regard for potential pitfalls of this line of thinking.

    Many of the various decisions you need to make really come down to one line: “Are you positioned correctly for the future given that you know today?” Although it sounds very simple it is by no means easy to do. Selling out of a position that performed well recently is hard enough, but buying into one that has done poorly in recent times is sometimes even harder.

    Keep in mind that no-one is going to be right 100% of the time. When you reach the point where you need to cut your loss and move forward it is imperative to make the choice by thinking ahead instead of looking back. Focusing on your discontent with a particular outcome will not add much value.

    When reviewing your portfolio it is important to determine the effectiveness of each strategy in context. A well-constructed portfolio will contain various strategies which will inevitably pay off at different times. Even if a strategy did not perform well compared to the overall portfolio it may have done exceedingly well given the goal (which may include risk reduction), and have good prospects going forward. Looking only at the bottom line of the strategy without context may lead to a sub-optimal overall portfolio and is detrimental to the eventual performance. Reviewing a strategy should have the primary goal of determining if the strategy worked, did what it was supposed to and whether it can be improved, reviewing thus helps to optimise the strategy. Reviewing should not necessarily be the step where the strategy is dropped or included.

    Successful investing is hard when you only follow the trend and invest in good news stories. You normally won’t be the first there and will most likely lag the early adopters. There is merit in strategies such as these but it relies on being quick to enter and exit and having a high tolerance for error. Spending too much time and energy on looking back may lead a person to follow the herd, leave little room for looking ahead and ensuring you are positioned for the future.

    South African investors looking back over the past year will have little to be happy about. Sure the Rand weakness may have pushed up the value of offshore assets in our own currency and there were little pockets of very good performing assets/strategies, but overall the sentiment’s been mostly negative. We are unsure of how long this malaise will last and when the outlook will turn positive. What we do know is that positioning going forward will be of utmost importance when volatility is high and the near-term outlook is not very positive, diversification and proper portfolio construction will get you out alive at the other end.

    Kind regards,

    Stefan Keeve

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

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    Permalink2016-06-22, 07:16:17, by Mike Email , Leave a comment

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