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07 Feb 2022

Safety First

Foord has often described itself as a ‘safety-first’ fund manager. But what does this mean in the context of investment returns and the stage of the market cycle? PAUL CLUER revisits the concept.

The father of value investing, Benjamin Graham, said that an investment operation was one that “promises safety of principal and an adequate return”. This seems to summarise what most of us want from our retirement portfolios.

Foord’s safety-first approach embraces this definition of investing. We eschew speculative activity, which carries unnecessary risk. To us, risk means loss of investment capital. The biggest destroyer of capital over long periods is inflation. Graham’s ‘adequate return’ must therefore exceed the long-term inflation rate for investors to achieve their investment goals.

So, we must preserve investment capital and compound inflation-beating returns over extended periods. Long experience has shown us that avoiding big losses (drawdowns) helps dramatically with this outcome, since compounding negative returns is as dangerous as compounding positive returns is helpful.

The risk of investment loss is countercyclical: risks increase as the business cycle matures and investment markets rally to new highs. Conversely, risk of loss abates after markets draw down in anticipation of a slowing business cycle or an external economic shock such as the COVID-19 pandemic.

After the March 2020 reset, global markets have been on a tear. Massive global monetary (lower interest rates and central bank stimulus) and fiscal (government transfers to corporates and individuals) interventions fuelled the ‘everything rally’, pushing global share bourses to all-time highs.

The US S&P 500 Index has doubled since its March 2020 lows. Global bourses in aggregate have gained 92% in US dollars. In South Africa, the FTSE/JSE Capped All Share Index also doubled, with the resources index returning a staggering 177% in rands.

Concurrently, labour shortages and supply constraints have raised the spectre of uncontrolled inflation. Global bond markets have been the first to retrace on the prospect of hard choices which central bankers will need to take.

Coupled with worrisome global geopolitical risks, high valuations and rising inflation pose threats to investment portfolios that warrants caution. Foord’s strategy has been to have a lower than average weight to the most frothy areas of the market, which include stratospheric US tech stocks, global bond markets, the SA listed property sector and—especially in South Africa—resources shares.

Many of these areas have pushed ever higher. As a result, our investment returns in the last 18 months have lagged less cautious peers. In hindsight, we were overcautious and should have captured more of the returns that were on the table. We have nevertheless delivered more than the yardstick ‘adequate return’ needed to compound long-term inflation-beating returns.

That said, the safety-first strategy worked in the 1997 Asian financial crisis, the 2008 Global Financial Crisis and the 2020 COVID-19 pandemic. It should again deliver the goods if 2022 proves to be a watershed investment year, should interest rates rise unexpectedly to counter the inflation threat.

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