The balanced fund dilemma

19 February 2014 - Ingé Lamprecht

Investing in times of uncertainty.

JOHANNESBURG - Balanced unit trust funds have seen significant inflows over the past few years on the back of generally good performances.

Also, amidst growing uncertainty and volatility, many investors have decided to leave decisions around asset-allocation to the professionals.

According to the Association for Savings and Investment South Africa (Asisa), four of the ten largest local unit trust funds are balanced funds.

As at December 31 last year, the Allan Gray Balanced Fund had R83.5bn of assets under management and the Coronation Balance Plus Fund R51.1bn. The Foord Balanced Fund attracted R31.6bn while the Coronation Balanced Defensive Fund lured R27.9bn.

Most Balanced Funds are Regulation 28 compliant, which means that pension funds are allowed to use it as investment vehicles. Regulation 28 permits funds to invest up to 75% of its assets in equities. A maximum exposure of 25% is applicable to listed property as well as offshore investments.

With the JSE All Share Index still trading near record-highs, interest rates at low levels and headwinds forecasted for the local listed property sector, does asset allocation limits mean that Balanced Funds find themselves between the proverbial rock and a hard place?

A conundrum?

Simon Raubenheimer, portfolio manager at Allan Gray, says while decisions around asset allocation are never easy, it is “very challenging” at the moment.

He says decisions are complicated by the fact that real interest rates are negative. The rand has also weakened significantly compared with two years ago, international markets have risen and the decision to take clients’ money overseas is not as obvious as it once was.

According to the Allan Gray Balanced Fund fact sheet for January, its fund had a total net equity exposure of 54.9%. The South African component was 40.9%. Less than 1% of the funds were invested in local listed property and 15.3% in local cash. The fund utilised its maximum offshore allocation.

Raubenheimer says the fund would probably have had a higher foreign asset exposure over the course of the last couple of years had it not be for Regulation 28.

Despite the rand having weakened, they still find a lot more relative value overseas, he says.

Its international partner Orbis has an investment universe of about 6 000 stocks and one would naturally expect them to be able to find more opportunities overseas than in South Africa, which accounts for less than 1% of the total world stock market.

Raubenheimer says despite the rand having weakened he would not advocate taking money overseas purely to benefit from a further weakening which may or may not happen.

“I think the opportunity really lies in the fact that there are several thousand companies overseas that we can pick from. That should be the rationale for investing overseas.”

With regards to the local equity market he says it is all about picking the assets that are more attractive on a relative basis.

He explains that they broadly concern themselves with two decisions. The first is around asset allocation. The second relates to finding the best relative value within the equities basket.

Raubenheimer says some of the shares included in its top equity holdings (for example Sasol, British American Tobacco, SABMiller, Remgro and Standard Bank) are not the cheapest they have ever been on an absolute basis, “but relative to an expensive market we find them attractive”.

He says one often finds quite good relative value where the large indices of the Alsi – resources, financials and industrials – diverge.

Resource companies have been the weakest performers on the JSE for a while and one would think that very attractive investment opportunities would present itself in this area.

However, paradoxically they still find relatively little long-term value amongst the miners that are listed on the JSE, particularly local gold and platinum miners. They continually test their views on the fundamentals of SA mining companies, Raubenheimer says.

Another opinion

Quinton Ivan, head of equity research at Coronation Fund Managers, says they do not really find that it is currently more difficult to balance Regulation 28 and performance considerations in their Balanced Plus Fund.

According to its January fact sheet, the fund has a 32.4% exposure to domestic equities and a 22.7% allocation to international shares. Approximately 8.5% is invested in the local listed property sector and 21.3% in local cash, with smaller allocations to other asset classes.

Ivan says clients often ask if they would increase their offshore exposure to 50% or 60% if they weren’t constrained by Regulation 28.

Surprisingly, their preferred exposure would not be much higher if they were given a clean slate and would probably be sitting at around 30%.

Ivan explains that if a significant amount of clients’ retirement savings were invested in offshore assets, it would lead to a currency mismatch between their liabilities denominated in rand and their assets denominated in a different currency and would create risk.

“So we don’t think it is currently a constraint to performance.”

Its overall exposure to equities (approximately 55%) is low compared to what it would consider to be a normal through-the-cycle level of about 65%.

He says the relatively low equity allocation is a function of expensive valuations in the local market although pockets of value are starting to emerge, for example in selected resources shares.

However, the opaque nature of the Chinese economy, which is a significant consumer of commodities and therefore an important driver of the earnings of resource companies, makes it difficult to have a high conviction in this regard.

Ivan says they still like the global shares that are listed locally such as Naspers and Richemont, but have taken profits and have started buying companies like Foschini and Woolworths that have been particularly hard hit by a selloff following disappointing trading updates.

While there is risk of a further sell-off in the local listed property market as interest rates around the world normalise and bonds and property re-price upwards, they are very focused on the quality names in the sector where some of this risk has been discounted at current prices.

​He says they probably own more cash than at any time during Coronation’s history as they are waiting for an opportunity to buy assets cheaply when there is a proper market correction.