Stability in uncertain times

By Nick Balkin & William Fraser

There are two components to the Nedgroup Investments Stable Fund’s investment objective. 



First, it aims to deliver inflation-beating returns over the medium term (three years). Second, it seeks to safeguard capital over rolling one-year periods. Balancing these two apparently competing objectives is more art than science – there is no substitute for experience and good judgment.



The understanding and management of risk is core to the Foord investment philosophy and our favourite definition of risk, is Elroy Dimson’s: “More things can happen than will happen.” It most certainly is not “what has happened.” Therefore we take a forward-looking approach and make investment decisions today that aim to protect investor capital across an array of future possible outcomes, knowing that most of those possible outcomes won’t happen.



Because we are dealing with potentially many futures, we cannot build a portfolio for only one possible outcome. This applies whatever our conviction of that outcome’s probability of occurring. We will also often be wrong in our views and forecasts. We must therefore have balancing positions that we think, on average, will achieve the fund’s dual objectives regardless of how the future transpires.



The fund’s 12-year plus track record under Foord’s management covers several market cycles. It offers a rich data set of one and three-year periods over which the investment objectives can be measured to assess the manager’s skill in achieving balance and getting calls more right than wrong. This is evidenced by the fund’s top-ranking return (1st of 36 peer group funds) since inception with an inflation-beating net-of-fee return above benchmark.



The chart below shows the fund’s return outcomes for all rolling 1, 2, 3-year returns up to rolling 10-year returns, compared to inflation. Pleasingly, the fund has never recorded a negative 12-month return (the lowest 12-month return was 0.4% and the highest was 19.0%). This data includes the extensive market sell-offs in the 2008/2009 global financial crisis and the March 2020 COVID-19 market plunge.



The fund has also comfortably met the return objective of providing moderate inflation-beating returns over rolling three-year periods without taking undue risk. The data shows a real return outcome 95% of the time over rolling 5-year periods and 100% of the time over rolling 7-year periods (the latter approximating the average business cycle).



 



Case Study: COVID-19

The COVID-19 market rout offers a perfect case study of how the fund does exactly what it says on the label. Markets underwent a severe correction in March 2020 with one of the fastest sell-offs in history, followed a month later by one of the fastest recovery rallies. An analysis of the returns of the 156 peer group funds in the ASISA – Multi-asset – Low Equity sector revealed a surprisingly high level of dispersion of returns in what ought to be a low risk category. Importantly, just because a fund has a low allocation to equity, doesn’t necessarily mean it is low risk.



So how stable was the fund during this period? Unlike many other funds, the Nedgroup Investments Stable Fund was true to label. It protected capital better than most of its sector peers when the markets ruptured through March. But it also performed better than most through the recovery relief rally in April. This is shown in the chart below where the red dot shows the fund placed well in the first quartile of low-equity funds in both months.



 



Importantly, there were no big, risky market-timing calls made across these months – the fund positioning has been relatively stable through this volatile period. The big calls were made years before in preparation for a range of possible outcomes, one of which included a scenario of severe market stress.



Around two years ago, we made a significant shift in the portfolio’s strategic position. Our forward-looking approach identified a number of risks starting to grow in importance in the coming years. The late stage of the global economic expansion cycle; one of the longest equity bull markets in history; the rapidly deteriorating South African economic prospects among others, all led to us adopting a conservative, defensive portfolio stance favouring global companies.



The strategy can besummarised as follows:

  • Low allocation to South African-focused companies given the gloomy domestic economic outlook (even before COVID-19).
  • Maximise allocation to foreign assets, mostly high-conviction global shares at very attractive valuations, with a greater proportion of assets in the flexible and conservatively-managed Foord International Fund where a well-timed put option protection strategy mitigated much of the downside market risks.
  • Large allocation to high yielding relatively safe five- to seven-year South African government bonds, given the benign outlook for inflation – a relatively certain holding period return exceeding inflation plus 4%.
  • Increased the holdings of physical gold (via the listed NewGold exchange traded fund and a global equivalent in Foord’s global funds) – a diversifying element in times of market stress.
  • Raised the liquidity levels across the fund – we know that liquidity becomes scarce when markets correct, precisely when you need it the most.


Looking forward, the inflation-beating return objective should be achieved by a combination of our very best growth investment ideas concentrated in the foreign assets and the high real yield from the South African government bonds. The large allocation to short maturity South African government bonds, physical gold and a sizeable offshore holding should protect investor capital if our downside risk scenario does in fact eventuate. Overlaying all of this, is a high level of liquidity (ability to sell assets quickly) provides the flexibility required to make the changes as and when necessary.

The Nedgroup Investments Stable Fund is exceptionally well positioned for the unfolding environment: giving you stability in uncertain times.