Moderate Balanced Fund sustains outperformance

By fund manager, Chris Freund

• Five years: 8.11% (benchmark: 6.58%)
• Three years: 5.27% (benchmark: 3.8%)
• One year: 5.34% (benchmark: 3.34%)

The benchmark for this fund is the peer group average of the ASISA South African-Multi Asset-Medium Equity. The Discovery Balanced Fund range, which includes the Moderate Balanced Fund, has one of the highest inflows in the industry, as per the Association for Savings and Investment South Africa (ASISA) (www.asisa.org.za/statistics/). The Moderate Balanced Fund has been top quartile over all periods and was a close runner-up in the Best Moderate Allocation Fund in the Morningstar South Africa awards earlier this year.

Three questions dictate the investment criteria for the Moderate Balanced Fund:

• Valuation: what price are we paying for the opportunity?
• Fundamentals: are the earnings, income, or economics improving?
• Investor behaviour: will capital follow our investment thesis?

Investment philosophy

We believe that sustained outperformance over the medium to long term is derived from focused, multi-specialist investment teams working together within a clearly defined process. We apply this multi-specialist approach in managing the Balanced Strategy by leveraging off the combined wisdom of strong in-house specialist skills, while simultaneously retaining complete focus and accountability with the dedicated portfolio managers.

The Discovery Moderate Balanced Fund investment philosophy can be summarised as follows:

• On balance, risk assets deliver a return premium over time.
• At turning points in the economic cycle, changes in economic growth momentum have an impact on asset allocation, equity style and sector performance.

On a ‘through-the-cycle-basis’, investing in companies where the expected future profits are being revised upwards and where the shares are reasonably valued will result in market-beating returns.

In order to achieve the desired real returns over time, the assets are skewed towards risk assets and listed equity in particular. In this respect a medium-term horizon is necessary to weather the inherent short-term volatility of equity markets and to capture both the equity risk premium as well as the benefit of reduced volatility that comes from time diversification in the markets. At appropriate times emphasis will shift from capital growth to capital preservation and in such instances cash holdings will be tactically increased.

Portfolio construction

The equity component is currently limited to 60% of the portfolio including international equity. 

The Moderate Balanced Fund has moderated equity exposure in order to reduce the risk of capital loss during unfavourable market conditions. The current asset allocation within this fund (as at 31 May 2018) includes a minimal allocation to SA listed property and commodities and is as follows:

• SA Equities – 39.6%
• Non-SA Equities – 18.3%
• Commodities – 2.1%
• SA Listed Property – 2.7%
• SA and Global Bonds – 18.9%
• SA and Global Cash – 18.4%

Portfolio constraints are monitored as part our risk and compliance process. Active management of asset class exposures is an important source of relative returns. The best risk-adjusted returns over the medium term are generated by what we refer to as strategic asset allocation by buying attractively valued assets best suited to the cyclical environment. As a consequence, the strategic asset allocation time horizon is typically three to seven years. Tactical asset allocation can improve returns by taking account of investor positioning and risk appetite and scaling strategic allocations accordingly. The typical time horizon for tactical decisions is up to six months.

Portfolio positioning

We believe the current momentum is in favour of a continuation in the improvement of global growth dynamics as underlying global economic fundamentals remain solid. Against this backdrop the cyclical bias is warranted, but we realise that markets may be ignoring some of the risks further out on the horizon. A robust business cycle is required to support risk assets generally. Valuations alone are unlikely to trigger a bear market, but stretched multiples coupled with a sharp slowdown pose downside risks.

In terms of our offshore allocation, we continue to be favourably disposed to corporates operating in Europe and Japan. These two are cyclical in nature and improving economic activity is leading to strong profit recoveries (and positive earnings revisions), valuations remain attractive (lower multiples on lower earnings base) and sentiment is healthy. Global fixed income markets have been slow to reflect the positive global growth dynamics. We remain wary of the asset class. In our view, should inflation and global monetary policy normalise, it is difficult to argue that negative or low real yields in global bond markets should persist.

Improving investment environment

Our focus remains on investing in companies with rising earnings expectations due to operationally-driven improvements or self-help measures. In general, the positive global growth backdrop should continue to support companies that are geared to the global economic cycle. Similarly, some local companies should benefit from any improvement in domestic growth. Some of our key holdings include; Anglo American, BHP Billiton, Naspers, Richemont, Sasol and Standard Bank Group.

Overall, we believe asset selection should trump asset allocation in the current environment, where we expect substantial dispersion in asset returns without them necessarily driving the overall direction of markets. We believe our investment process and philosophy should ensure consistency in our portfolio construction and help us navigate the uncertain terrain.

Disclaimer
Nothing contained herein should be construed as financial advice and is meant for information purposes only. Discovery Life Investment Services Pty (Ltd): Registration number 2007/005969/07, branded as Discovery Invest, is an authorised financial services provider. The views contained herein are not those of Discovery Limited or any of its subsidiaries and are those of the author/s.