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13 May 2014

A Fund For All Seasons

The Foord Flexible Fund of Funds is a top performer in the category of unit trusts that gives managers an unconstrained investment mandate. The lead fund manager of the three funds associated with the Foord Flexible Fund of Funds is Dave Foord, who tells Liz Still how he and his team sift through the clutter and avoid the obvious in search of the underlying promise in funds anywhere in the world.

ALL OF THE GUESTS ON YOUR favourite current affairs radio show have predicted that the rand will weaken over the next two years. Will it or won't it? Your neighbour has smugly informed you that he has been invested in the fund that won the Raging Bull Award for the Best South African Equity General Fund over the past five years and has suggested that you should do the same. But an article in a business newspaper has noted that offshore equities are showing good value and, given the current political turmoil in South Africa, surely it makes sense to invest offshore?

You are numb with uncertainty, caught in a bewildering information overload. Your hard-earned cash is sitting in a money market account with a return lower than inflation, and you know you must invest it somewhere else. But what sort of unit trust fund should you choose?

Enter the worldwide multi-asset flexible subcategory of unit trusts. This sub-category mandates fund managers to invest their rand-denominated portfolios in any country, including South Africa, and in any type of asset (equities, bonds, listed property or cash). This is the "no excuses" subcategory: fund managers cannot blame poor performance on a restricted mandate. Currently, there are 30 funds in this sub-category, the oldest of them launched in June 1998, but most have track records of just over three years.

PlexCrown Fund Ratings recently named the Foord Flexible Fund of Funds as the leading fund in the broad category for South African-domiciled foreign and worldwide funds for periods to the end of the fourth quarter of 2013. The PlexCrown rating system takes a number of factors into consideration when evaluating funds, including risk-adjusted returns, consistency, downside risk, managerial skill and performance over three- and five-year periods. Three-year risk-adjusted returns were allocated a 40-percent weighting and five-year returns were allocated a 60-percent weighting in the combined South African-domiciled foreign and worldwide category. The risk-adjusted returns are based on three ratios: the Sharpe, the Sortino and the Omega.

The manager of the Flexible Fund of Funds is also the founder of Foord Asset Management and its global chief investment officer, Dave Foord, who has won many prizes and awards over his long investment career. He started Foord Asset Management in 1981 with the assumption that investors' money should be managed with the same degree of care and dedication that he would give to his own money.

PERSONAL FINANCE: Many fund managers say that one of the biggest challenges over the next 15 years will be the capacity of the asset management industry to provide value in a low-return environment.

Dave Foord: Their observation holds some merit when thinking about investments at the aggregate asset class level over the next three to five years, but then there has not been a lot of added value in the high-return environment either. However, as a high-conviction stock-picker (which concentrates its portfolio only on investment managers' "best ideas" about the shares in which to invest), we are more interested in the opportunities we can find at the level of the underlying securities (shares or bonds or other listed instruments). A low absolute return environment with high volatility across shares and sectors is typically good for high-conviction absolute return investment managers such as Foord.

Our investment approach is particularly well suited to low absolute return environments. It is in these environments that stock selection becomes a proportionally larger component of total returns. Those parts of the industry that rely mostly on markets that are trending up to generate real (after inflation) returns will likely find the going a lot tougher. So we see it as their problem, not ours.

Is Foord Asset Management concerned about the "threat" posed by the increased use of exchange traded funds (ETFs) and other passive investment products?

The increased use of ETFs and other passive vehicles will make investment markets even less efficient than they currently are. Passive strategies allocate capital purely on the prevailing price of the securities in the index, taking no account of the underlying value of the securities in which they invest. These pools of capital, as they get larger, will increasingly drive the disconnect between the price of the securities and their underlying value, and they will create inefficiencies that good active managers will be able to exploit for the benefit of their investors. We see no threat at all – passive funds offer guaranteed mediocrity and they do not offer any scope for the most important decision of all: asset allocation.

Tell us more about your investment team.

Over the past 10 years, we have deliberately and purposefully increased the breadth and depth of our investment team. We have 16 investment professionals in our team, including eight portfolio managers. The portfolio managers have been at Foord for between five and 20 years and, on average, have more than 10 years' industry experience. In 2009, we introduced a multiple counsellor portfolio management approach whereby portfolios are split between three or more portfolio managers. This approach allows us to mitigate the risks of losing a key person and ensures a diversity of ideas. Each portfolio manager has full accountability for all investment decisions in their portfolio allocations. This responsibility is not given out lightly. The Foord investment philosophy is well percolated through this group, and we have more than sufficient capacity to ensure that we continue to deliver the returns that our investors expect, regardless of any member of the team becoming indisposed.

Your annual fees for the Foord Flexible Fund of Funds, as measured by its total expense ratio (TER), were 3.65 percent at December 31, 2013, whereas the average fee for funds in the worldwide multi-asset flexible sub-category was 2.44 percent. On the other hand, your fund was one of only two that had a performance fee with a claw-back for negative performance built into the fee structure.

A high TER happens with performance, and we are the best-performing fund in the sector over five years. Given the strong returns generated in the fund over the past few years, it is no surprise that the TER is at the high end, but, after fees, the returns are still the best in the sector over five years.

Foord is still a relatively small asset management company. Do you think there is an optimum size for an asset management company in this country when investing in a South African-only equity mandate?

Optimum size is a moving target that is difficult to quantify at any point in time. Although size relative to total value is important, liquidity is also a key variable, but it is exactly that: a variable. It's usually there until you need it most. Also, taking longer to enter and exit a position will sometimes be useful and sometimes be a hindrance. The context and market environment is important. We have a small proportion of our mandates in equity-only products deliberately.

A fund with a worldwide flexible mandate requires a manager with a keen appreciation of political change and an understanding of demographic and social trends, as well as macro and micro economics. Do you read voraciously? Attend conferences? Have access to influential people? Watch Bloomberg all day? How do you keep yourself informed of the necessary changes in order to make the decisions you are required to make?

The most successful investors are independent thinkers and perpetual scholars. The ability to read between the lines, draw connections between what can appear to be unrelated data points and identify crucial turning points are all-important traits. The biggest challenge is avoiding the noise and market chatter and focusing on the commentaries, data points and events that are likely to make an impact on long-term trends. So in answer to your question: all of the above to a greater or lesser degree, and much, much more.

Do you have a few key facts or statistics by which you set your investment compass? If so, what are they?

First, price and value will often disconnect. Second, future earnings. Third, apply probabilities to various possible scenarios and manage the risk in the portfolio accordingly. Fourth, the possibility of an unexpected outcome is usually greater than can be predicted. Fifth, diversification is truly a free lunch – meaning that it offers benefits without any cost. And last, focus on the big decisions.

Foord's website says that its investment philosophy is sometimes contrarian. What does this mean?

By definition, if one wants to stand out from the crowd, one has to behave differently. Importantly, it is dangerous to be contrarian simply for the sake of it. We do not automatically take the other side simply because no one else is there. It is usually our longer investment horizon that results in positions that might appear "contrarian" to those working to shorter time-frames. We do not like following the herd. Great opportunities are unlikely to be found where others have trampled.

The mandate of the Foord Flexible Fund of Funds is totally unconstrained; it allows the fund manager to invest in any asset class and in any geographic region without any limits on the amounts invested in each class or region. Please explain where you start and which decisions you make first.

The process for this fund is broadly the same as for all our global balanced mandates. We are top-down, which means that we have a strong focus on key big picture trends, as well as bottom-up – in other words, we have an equally strong focus on details such as company valuations and factors specific to individual securities. The ultimate portfolio construction reflects the diversified mix of asset classes that we think is most likely to achieve the required return over time at manageable risk. The asset allocations reflect our highest-conviction underlying security ideas. Importantly, we seek out balance, so that the portfolio will deliver a reasonable outcome regardless of how the market scenario plays out. We analyse risk and keep adjusting the portfolio according to the probabilities. The process is fluid and flexible.

There is a built-in irony in the Flexible Fund of Funds: it gives the manager a totally free hand to diversify (described as the "only free lunch in the investment industry") and yet the most successful funds in the worldwide multi-asset flexible sub-category have been successful by building high conviction portfolios.

I disagree with your statement. Ours is the best performing fund, and we have not been "shooting the corners", as we refer to it in the industry – in other words, taking large, risky, one-way bets in the portfolio. It is, however, entirely possible for a high conviction portfolio to be well diversified. This fund certainly is. When you think about the fundamental economic drivers of investment returns and move away from the arguably arbitrary classifications of asset classes, sectors, domiciles, and so on, which have come to dominate the industry's approach to thinking about risk, this becomes clear. Also, diversification is important, but should not be seen as fixed. In other words, where one has higher conviction in investment terms, less diversification is required than when one has lower conviction.

One of the key aspects of your equity selection process is to buy at the right price. How do you ascertain the right price?

We determine what is cheap or expensive by reference to the expected future cash flows. That is why our approach is forward-looking and why we forecast earnings/income over three to five years. We do not rely on mean reversion thinking – which is what we call the expectation that the future behaviour of asset prices will conform to past patterns – for our perspective on price.

Five years ago in January 2009, the Flexible Fund of Funds had 75-percent exposure to South Africa. In January this year, it had 36.6-percent exposure. Over the same period, you have increased the fund's exposure to the United States (from seven percent to 21 percent) and the Pacific Basin (from three percent to 18.9 percent). Could you take us through the rationale behind these shifts in exposure?

The regional allocations of the portfolio reflect the changing opportunities over the time period. As local markets continued to run and the currency strengthened, largely on the back of strong emerging market inflows, the relative attraction of foreign assets started to increase and the portfolio positioning moved to reflect this. Our company research identified the most attractive opportunities in the regions you have mentioned. I should also point out that the domicile of the stock is not necessarily an accurate reflection of its underlying economic exposure. So the geographic exposure is incidental; our stock selection is based on other considerations.

Although the fund has considerably reduced its exposure to South Africa, it is still at 36.6 percent. Most of your competitor funds have very little South African exposure. This suggests that, if the rand weakens, your competitors will benefit from currency depreciation, which will affect your rankings. Is this correct?

Yes, but despite the likelihood that the currency will weaken, there is a scenario that gives it a good chance of strengthening. We do not build all-or-nothing portfolios, because there is always a chance that we could be wrong. Also, the type of South African equity exposure within the 36.6 percent is important; as I said before, the domicile of the stock is not necessarily an accurate reflection of its underlying economic exposure.

Last, the aim of the portfolio is to achieve a return greater than inflation in South Africa (as measured by the Consumer Price Index) plus five percent. To have the portfolio 100-percent in foreign assets is, in our opinion, not entirely prudent from a risk management perspective. Plus, we do not concern ourselves with others or rankings. Our target is the benchmark objective.

To what extent do you analyse the performance of your fund with your team? Do you try to learn lessons from past mistakes?

That is a critical part of our process. A large part of my role as the chief investment officer is to make sure that we learn from our collective and individual experiences, particularly the negative ones. We spend more time discussing our mistakes than we do discussing our wins. We know the importance of critical self-evaluation and how experience is the only reliable teacher in this industry. It is important to be open to the lessons that experience dishes out.

Is there a blueprint for managing the fund, or is a high percentage of the fund's success due to the intuition of the fund manager?

There is no substitute for good judgment. There is no blueprint, in the same way as there is no "supreme text" on how to become a good fund manager. However, we have, over many decades, refined an investment philosophy that underpins all the portfolios we manage. We have also developed a team of experienced portfolio managers with proven good judgment. Given that this is combined within an organisational structure that is aligned to long-term investment outcomes and supports learning and critical self-evaluation, we believe that the performance successes of the past are repeatable in future.

This article, written by Liz Still, was first published in Personal Finance Magazine, 2nd edition 2014, a quarterly publication of Independent Newspapers, available at leading retailers and bookstores. Copyright Personal Finance and Independent Newspapers.


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