In South Africa, diversification takes many forms – it can be related to gender, race, culture and even spiritual and/or religion. So, in the multi-management space, particularly within the equity fraternity, what do we mean when we say diversification?
At Absa Multi Management (AMM), we pride ourselves in having a two-pronged approach that looks at the qualitative and quantitative moats of asset management firms across the spectrum of asset classes. Our qualitative and quantitative attributes give us the competitive edge towards what we believe constitutes superior manager selection. We leave the shopping basket, also known as the FTSE/JSE, to the underlying managers to do the stock selection. Their skillset lies in the selection of stocks across the three key sectors:
Naturally, the South African FTSE/JSE is concentrated as there are approximately 160 investable stocks for these asset management firms to pick from. The trick lies in what the philosophy of the asset management firm is and how they define what their truest style actually is – or in this case, how they prefer to wear their blue jeans. Given the style metrics, we then examine through holdings analysis, how the blue jeans should be worn, and for which occasion.
We all know the versatility that comes with a good pair of jeans – a snug fit for either male or female is key. Blue jeans are also not very demanding, as you don’t have to be a fashion connoisseur to determine how they should be worn. Generally, how the jeans are worn is dependent on the occasion, a very diverse and timeless styled item.
For an investor, the “occasion” is what the prevailing market environment may be at that point in time. This environment may be an expansionary or contractionary one. In an expansionary market environment, some asset management firms, styles and or themes will deliver stellar investment returns and drive alpha profiles that will make investors happy. The converse is applicable to a contractionary occasion. The finesse lies in the benefits of diversification within the multi-management space and this is achieved by analysing the traits and/or DNA of a particular asset management firm, through both a returns and holdings analysis process.
The occasion that determines when and where to wear your blue jeans is also embedded in the artistic element driven by the mathematical, scientific observation of which styles and/or characterisations have performed well through time. An intricate trend here is to ensure that the blend of asset managers into a particular solution do not cluster into one style or occasion. As the old adage goes: don’t put all your eggs in one basket. As multi-managers, we are able to hold the notion of this adage by characterising the different market occasions and asset management firms into clusters, even in a “concentrated” local JSE market through observation analysis. This can be done not just for the local equity market but also for diversification across geographies, sectors, companies and or factors/styles. We will focus on the latter to illustrate how diversification not only across asset managers but also through the various styles of each theme is beneficial and tends to do well.
Factor models were developed in the early 1960s and through time, the systematic drivers of risk and return in capital markets have changed. With the current COVID-19 pandemic, the underlying intricacies that influence these factors and/or characterisations have also changed (as reflected in the table below).
The table above sets the tone for how important it is, from a manager selection perspective, to ensure that we are not exposed to just one particular style, even in the selection of asset management firms. It is also important that there is diversification across the factors, just as there would be in having a good pair of jeans. When identifying factors that drive returns, we look for factors that firstly provide a positive payoff over time. While manager selection is not a riskless exercise, our objective is to provide a consistent return profile. It may not always be first quartile, but it will deliver sustainable risk-adjusted returns through time. Resultantly, we focus on factors that have proven to provide sufficient returns to compensate for that risk quantitatively as well as qualitatively. After all, risk is pivotal in all that we do, but it is not a sole determinant factor.
As previously stated, the manager selection process is two-pronged and also focuses on softer qualitative factors, such as business sustainability plus the profitability of an asset management firm, market perception of the firm, investment professionals within the firm and whether that firm has an integrated environmental, social and governance (ESG) and BBBEE process. We also believe that when we analyse factors, these must be backed by solid economic reasoning.
An additional sanity check that we apply to ensure that we have a holistic solution, entails the portfolio construction team checking whether a factor has low correlations with other factors. Additional mathematical analysis, such as the CUSUM (or cumulative sum control chart) scheme analysis, also takes place. This is done to ensure that investors have a well-rounded multi-management solution that is diverse, not only by the names, styles and any other risk attributes included in the portfolio, but also by ensuring that it is as diverse as those blue jeans that can be worn up or down. Simply put, we believe that exposure to these varying factors ensures that the portfolios are suited for different market occasions and style biases – otherwise, all our eggs would essentially be in the same basket.
While the style of blue jeans may evolve over time, in line with fashion trends, they still remain simple blue jeans. The same also applies to prevailing styles and/or factors through time (as seen in the table below). Some styles or themes are how some single asset management firms have identified themselves and consequently characterise their shopping basket.
Thus, exposure just to one particular theme or style may be in favour in one period and not so much in a different period. Diversification in the multi-management world therefore ensures that the contours of each style is exposed, thus ensuring a perfect fit.
- Value: FTSE/JSE Value Index
- Growth: FTSE/JSE Growth Index
- Yield (sometimes this is also called Carry): FTSE/JSE Dividend+ Index – this shows the higher dividend paying stocks. The official description from the JSE: “Select and measure the performance of higher yielding stocks within the universe of the FTSE/JSE All Share Index. The FTSE/JSE selects the top 30 stocks by one-year forecast dividend yield.”
- Size: FTSE/JSE Small Cap Index – this is just an index made up of the small cap counters on the JSE. This can also be loosely seen and/or translated as deep-value kind of stocks.
The above table uses factor indices as derived from the FTSE/JSE and is not dependent on any benchmark. The results show how different factors have performed from 2007 to 2021; and highlights the different styles that may prevail in the market. For example, in 2009, the styles shift in rank and dominance from Value to Size in 2021. Exposure only to Value in 2012 would have resulted in poor performance relative to the performance seen in 2021. In the same year (2012), exposure only to Growth would have boded well for relative performance in that particular year. The opposite is true for Growth in 2021. So what does this all mean?
Our manager selection process is aimed at identifying the inherent differences that exist within various asset management firms. With the benefit of hindsight, we are better able to understand the moats, qualitative and quantitative metrics of our selected asset management firms that give us differentiated returns. This allows us to formulate optimally blended multi-manager solutions. This is also beneficial to the investor because as the market tends to rotate towards a particular style and/or factor that solution is not dangerously exposed to a single driver of return but an optimal blend of factors from different underlying asset management firms.
In addition, the graph below shows the cumulative performance returns through time of the Absa Multi Management best-blend equity solution.
It also becomes clearer that if all your eggs are held in just one “style bucket” or if you only have a single manager, one will experience the full magnitude of the volatility that applies to that "style bucket" or firm. However, if one is invested in a carefully blended combination of managers, where qualitative and quantitative attributes plus the risks thereto are analysed, one will be able to offset the impact of such volatility as the sum of the parts will always be greater than the whole when portfolios and/or solutions are skilfully constructed. Part art and part science – a dose of objectivity, subjectively creates optimal solutions.
It is clear that there are robust diversification benefits to multi-manager investing that can be worn up or down just like a pair of blue jeans.