March 2017
Investment review
Why manager diversification
is key
No individual manager will perform well all the time.
is 2008, 2011 or 2013), the pattern repeats itself.
This was the basic premise upon which PPS Investments
was launched and has been constructing portfolios for
almost a decade now.
Part of the reason for this variability is that investment
strategies perform differently in different market and
economic environments. Each asset manager has a fairly
unique approach to investing that gives rise to managerspecific risk. An asset manager’s investment strategy does
not only determine how an investment idea pertaining to a
security or asset class level is evaluated (e.g. focusing on
earnings growth, quality of management, providing
sufficient margin of safety etc.), but also determines the
weight it could carry in the portfolio (extent to which the
manager is willing to allocate to the idea). As a result,
different asset managers could have very different views of
or positions in the same investment with the same
information at hand.
When we launched the business in mid-2007, little did we
know that we were about to face the worst financial crisis
since World War II. Almost a decade later, investors are
still dealing with the after-effects of extremely
accommodative monetary policies across most of the
developed world. How asset managers were positioned to
take advantage of the events that transpired over the past
decade depended on the managers’ investment strategies.
It is widely accepted that portfolios should be diversified
across securities, asset classes and geographies to include
as many uncorrelated sources of returns as possible and to
minimise the impact of short-term volatility of any of these
factors.
Manager-specific risk is probably the most unappreciated
diversifiable risk that investors face. As a multi-manager,
we provide investors with that additional layer of
diversification by combining asset managers with different
but complementary investment strategies.
But why not simply invest in the top-performing manager?
The simple answer is that the top-performing manager is
highly unlikely to be the best performer all the time.
The asset manager ranking table clearly shows just how
volatile and unpredictable the relative returns of asset
managers are over the short term. Each colour represents
one of the largest asset managers in South Africa, while
each column represents the relative ranking of the managers in each calendar year since we launched the business.
From the random distribution of colours, it is evident that
it is indeed impossible to predict with any confidence
manager will be the top performer over the next 12-month
period purely based on performance over the most recent
12-month period.
Source: Alexander Forbes and PPS Investments
An investor that allocated capital to Manager A based on
its strong performance in 2008 would have been
disappointed by poor relative performance between 2009
and 2014. If the investor capitulated in 2011 and switched
out of the strategy in search of better returns, the investorwould have missed out on the strong performance
delivered by Manager A during that year. It does not matter
when the investor made the initial investment (whether it
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For example, a value-orientated manager had to live with
severe underperformance for lengthy periods of time as
already cheap resources counters continued to underperform expensive multi-national industrial companies with
better earnings visibility and attractive dividend prospects,
in a low-yield environment. A benchmark-focused manager,
whose process is designed to establish positions in relative
terms (underweight versus overweight), typically benefited
more than a benchmark indifferent manager did from the
phenomenal growth of Naspers into a R1 trillion establishment, as the share became a significant holding inthe
Shareholder Weighted Index (from 1.6% a decade ago to
18.6% at quarter-end). The extent to which fixed income
investors were affected by the write-down of African Bank
debt in 2014 was a function of the managers’ ability to
appropriately assess the underlying credit risk and willingness to move down the capital structure for additional yield
pick-up.
As multi-managers we spend the bulk of our time
trying to understand the main drivers of individual manager
returns and recognising the environment in which
managers are expected to perform. It is impossible to know
which investment environment will apply in the next 12
months and therefore, it is very difficult to know which
manager would be the top performer. We do not try to
time the market by switching between different investment
strategies. Our focus is rather on combining managers that
give us exposure to different sources of returns, ensuring
our portfolios are not overly exposed to a particular view.