This article was first published in the third-quarter 2015 edition of Personal Finance magazine.
Multi-manager investment company 27four Investment Managers was launched in 2007 by a gutsy woman with one client and a computer. Fast forward to 2015 and the company has R13 billion under management, three subsidiaries and many investment awards decorating its office walls.
Fatima Vawda, 27four’s managing director and majority shareholder, named the company after April 27, 1994, the date of South Africa’s first democratic election. She hoped the name would be a tangible salute to South Africa’s new democracy and represent the change she wanted to bring to the asset management sector.
Vawda’s personal and work history reflects an unflagging determination to progress up the social, academic and corporate ladder. She was not born with a silver spoon; she says that her humble beginnings help her to stay focused on the central mantra of the firm: the necessary respect for protecting “other people’s money”.
After graduating from Wits University with a master’s degree in applied maths, she went on to lecture in the subject in the university’s Department of Computational and Applied Mathematics. She then joined Standard Corporate & Merchant Bank as an interest rate derivatives trader, before moving to Peregrine Securities as a researcher and trader. In 2003, Vawda founded Legae Capital, which became a leading hedge fund multi-manager in South Africa. She is chairperson of Legae Securities in addition to heading up 27four.
Asked which character traits she thinks are important for a fund manager, she cites one above all others: curiosity. “I think fund managers should be endlessly intellectually curious,” she says. “For me, this is expressed in a love of travel. I love the hands-on research we do in different countries before an investment decision is made. Travel gives you, as an investment researcher, much more than you could ever find in an investment report. You get to ‘join the dots’ when you visit a country and talk to the people there. Travel is a wonderful teacher; you learn to look in unexpected places to take the pulse of a country.
“I went to Greece recently, and while I knew about the state of the economy from reading investment reports, it was quite another thing to see the suffering of the Greek people and the impact on the economy, in the form of visible poverty, graffiti-covered walls, and so on.”
About 80 percent of 27four’s assets are from institutions such as pension funds, and the remaining 20 percent are from retail clients. The company has a suite of institutional funds including an African fund and eight retail unit trust funds.
In addition to the 27four Balanced Prescient Fund of Funds, the company has two other unit trusts that are classified as multi-asset funds, two Shari’ah-compliant funds (one in the local general equity sub-category and one in the multi-asset high-equity sub-category), two global funds denominated in US dollars (the 27four Global Balanced Fund of Funds and the 27four Global Equity Fund of Funds), and the rand-denominated 27four Global Equity Prescient Feeder Fund.
The company has a team-based investment decision-making process and employs eight investment professionals: four in Cape Town and four in Johannesburg.
The 27four Balanced Prescient Fund of Funds is a multi-asset medium-equity fund, which can invest up to 60 percent in equities. It was launched in November 2008 and has R579 million under management. It won a certificate for risk-adjusted performance at the 2015 Raging Bull Awards, co-sponsored by Personal Finance. The fund earned the award because it had the best risk-adjusted returns over three years to the end of 2014.
Personal Finance: As of June 2015, there are 128 funds in the multi-asset high-equity sub-category, 70 funds in the medium-equity sub-category and 115 funds in the low-equity sub-category. How does a new asset management company break into this market?
Fatima Vawda: We made inroads by introducing an institutional process and competitive prices to the retail market. Given our strength and success in the management of retirement fund assets, transferring this skill to the retail market was a natural progression for our business. We kept our heads down and focused on performance by producing low-risk, solid, targeted returns.
We also identified and exploited a number of gaps in the market. We introduced an African fund and designed investment solutions that are Shari’ah-compliant.
How do your funds differ from those of your competitors?
They compete very favourably on fees, and we have favourable risk-return ratios. We have a consistent investment strategy and aim to take less risk for the returns we target. These are small things, but they all add up and become significant.
Take us through the process of asset allocation. How do you decide how much of a portfolio to allocate to, say, equities, cash, or offshore?
We believe that asset allocation – how the fund manager divides the portfolio among equities, property, bonds and other types of assets – is the single biggest contributing factor to the performance of a fund. It is the cornerstone of portfolio construction. Relatively speaking, worrying about how much equity exposure there is in a portfolio is much more important than worrying about which companies you choose to invest in.
The target return of the 27four Balanced Prescient Fund of Funds is inflation plus five percentage points. We have researched the long-term asset allocation necessary to achieve this objective; historical returns over a 40-year period show that an allocation of about 60 percent to equities is necessary to get this return. However, over the short to medium term, we may be underweight or overweight in our long-term asset allocation, depending on our views on the behaviour of economic variables, such as interest rates, that drive the performance of financial markets.
The problem is that higher equity exposure comes at a higher “risk cost”. There are many definitions of risk and many statistics that can be used to measure risk, but, ultimately, we understand risk as those factors that prevent us from achieving our desired outcome.
We know that different investment environments present different levels of risk, so we combine our risk-budgeting model with a top-down view – a bird’s-eye view of the economy, if you like – and tweak our asset allocation accordingly. We do a lot of research to understand the present and future environment, to ascertain why one region, asset class, sector or style is under- or out-performing, and then adjust our model.
We use a range of tools to assist the fund manager in deciding how to make small shifts within the portfolio for greatest return and least risk.
When equities are considered expensive, we might reduce our allocation to equities a little, or allocate a higher weighting to an equity sub-sector considered less risky. We would also use our research to allocate assets to different sources of return, which, in our view, could out-perform. We might apply a short-term tactical asset allocation “tilt” to take advantage of an opportunity, or to protect against a short-term market downturn.
Since the balanced fund is a fund of funds, you don’t actually choose the underlying investments yourself; you choose funds. Take us though the process of how you select the underlying funds.
Claire Rentzke, 27four’s head of manager research, is responsible for finding up-and-coming local and global and fund managers who have the skills to deliver against our expectations.
We have enjoyed some success in combining large, well-known managers and smaller, untapped “boutiques” that we believe possess a distinct performance advantage because they are more nimble and opportunistic, especially in asset classes where the ability to take calculated risks and move swiftly is vital to success. Although most funds of funds screen potential funds using quantitative (number-based) tools and due diligences, Claire is particularly good at analysing the qualitative (softer, less easy to measure) components of different funds and investment teams.
Claire and the rest of the investment team work closely together to ensure that we choose fund managers whose views on the economy best match our own. The chosen managers should have similar views on which sectors to avoid, which companies to invest in and how much to invest in them.
In the recent past, for example, broad research suggested that equities in the United States would do well because of quantitative easing and so we took advantage of the improving US economic outlook through our exposure to the Franklin Templeton US Small-Mid Cap Growth Fund. Through the Investec Global Franchise Fund, we also invested in larger blue-chip companies generating global revenues.
Many investors remember that when funds of funds were first launched they were far more expensive than single-manager funds, because they had another level of fees. However, a glance at the funds in the multi-asset medium-equity sub-category on the website of the Association for Savings & Investment SA shows that the fees of 27four’s funds are well below average. Why is this?
Ultimately, investors want the best after-fee returns over time. The latest total expense ratios (TERs) of our three multi-asset funds are 1.38 percent (high equity), 1.31 percent (medium equity) and 1.36 percent (low equity). There are three levels of unit trust fund pricing. The first level of fees pays for the administration of the actual fund, the buying and selling of holdings, custodian fees and trustee fees. Across the industry, there is not much range in the fees for these services, and they amount to about 0.015 percent of a portfolio’s costs.
Then, in the case of funds of funds, there are the fees payable to the managers of the underlying portfolios, including performance fees. These range from 0.07 percent to more than one percent for an offshore equity portfolio. This is where we have been able to add value for our investors: because of our institutional background, we have been able to negotiate fees structures that are closer to the institutional norms than those offered to retail funds.
Then, at the third level is our fee: we add 0.025 percent, which we know is less than some of our competitors. Some fund-of-funds portfolios have fees closer to 0.5 percent.
So, depending on the offshore weighting of our funds, the TERs should come out at between 1.3 and about 1.4 percent, which we know is competitive.
Given the fact that you are very aware of the impact of investment costs, why do you not use more exchange traded funds (ETFs) and passive funds in your funds of funds?
We like passive funds for the reason you suggest, and we use them in both our local and global portfolios, but there also has to be a good match between the underlying holdings of the ETF or passive fund and the companies/shares that we actually like.
For example, a holding in our balanced fund is the Sesfikile SCI Property Fund, an actively managed property fund. If we were positive about the property sector as a whole, investing in an index-linked fund would be fine. But we think that certain companies within the property sector will out-perform the sector as a whole, so we prefer to go with an actively managed fund that can pick up these opportunities.
Another example is our exposure to the Sanlam Value Fund. If you look at just one component of value – the dividend-paying capacity of value shares – you might be tempted to opt for the Satrix Divi Plus, an ETF with a good annual fee and a dividend yield of just over four percent. But we know that the underlying holdings of the Satrix fund include companies that do not actually represent value in the true sense – in other words, some of the bigger companies are just giving away dividends because they do not know what else to do with the money; they are not using their intellectual capacity or industry knowledge to employ capital on behalf of their investors.
The latest fact sheet of the fund shows that there are 11 funds in the portfolio, as well as cash holdings. Isn’t this rather a lot of funds? Are you not at risk of getting index-type returns with so many?
There are seven equity funds – four local equity funds (including a property fund) and three offshore equity funds – as well as a local bond fund, local cash fund and two local income funds. But the equity funds have different style mandates. We believe that we add value by allocating our equity exposure according to funds that match our view. Fortunately, this shows in our performance.
Tell us more about how your risk-management team operates.
There are many ways to measure risk, including behavioural risk. In addition to ensuring that our funds are compliant with regulations, our risk-management team’s job is to monitor overall market risk and credit management. They have to quantify and evaluate the factors that contribute to investment risk.
Our notion of a “risk budget” works well for us; we know we have to include risky assets in our portfolios, otherwise they will not meet our objectives. On the other hand, it is our risk-management team’s job to calculate just how much of our “risk budget” they take up, and not “overspend” our risk parameters. We continually have to measure the probability that our “risky assets” will not deliver our hoped-for returns.
As a team, we meet weekly, monthly and quarterly to discuss risk, the performance of underlying funds and the success or otherwise of our big decisions, such as how much of a portfolio should be invested offshore and which countries should be chosen.
At our two-day quarterly meetings, we discuss our views on core economic variables and how projections for these may have changed since we last met. We spend a lot of time looking at the key components of inflation and likely interest rate changes, which are a source of potential risk to our portfolios.
As well as ongoing risk management, we also spend a lot of time back-testing – in other words, we go over decisions we have made in the past to see whether we would make the same decision again with the benefit of hindsight.