Many pension fund trustees and consultants have structured their portfolios with two assumptions: that equities will outperform other asset classes; and they can only benefit from putting 15% of their assets offshore.
But the traditional global balanced portfolio has not delivered over the past year. The average balanced portfolio in the Alexander Forbes global Large Manager Watch (LMW) has provided a negative return of 11,7% over the year to March and, perhaps more alarmingly, a meagre 5,6% annualised return over the past three years.
Asset managers have rushed to offer absolute-return products as an alternative to peer -driven balanced or relative products. Sanlam, Stanlib and Prudential have all launched successful inflation-linked products and Coronation and Investec have set up separate absolute-return teams.
The absolute-return trend is providing a strong opportunity for managers whose core skill is managing risk, such as Peregrine Quant, Prescient and Cadiz. But most retirement fund trustees, not knowing which way to turn, have remained in balanced products.
RMB Asset Management chief strategist Richard Simpson says balanced portfolios have proved to be an effective vehicle for providing absolute returns over the longer term. RMB's own balanced portfolio has given an 8,5% average real return over its 14-year history.
Old Mutual Asset Managers (OMAM) asset allocation head Charles de Kock says retail investors continue to seek the safety of fixed interest, but the market will eventually experience a cyclical swing back into equities.
De Kock says valuations within equities are broadly neutral, though OMAM especially likes banks and fixed-investment companies.
However, asset managers seem to be getting worse at reading markets. In their domestic balanced portfolios, equities continue to dominate, ranging from 58,7% (Investec) to 73,6% (Allan Gray).
Most work to a benchmark of 25%-35% bonds, and good bond performance should compensate for the poor equity markets. Yet the bond allocations were as low as 14,4% for RMB and 15,5% for Stanlib, and up to 25,7% at Allan Gray, which has almost no exposure to cash. Reading the currency continues to be the make-or-break decision for investment managers.
The strength of the rand and the unexpectedly weak international equity markets punished those managers with high international weightings, just as it helped them in the previous year.
The most dramatic swing has been in Stanlib, which briefly overtook Allan Gray in the 12 months to March 2002. However, Stanlib has fallen to the bottom of the global LMW, not least because of its average 20% offshore holding, which was 6% ahead of the peer group.
Stanlib chief investment officer John Koel says too many rand hedges and too few bonds also contributed to underperformance.
But, he says, the funds are positioned to reflect the view that equities are cheap and local bonds are fully priced at best.
Koel says the rand is vulnerable to a correction, but it is not a time to move aggressively into global equities as job losses continue in the US and consumers are not in a position to lead a recovery. Europe is still in a policy muddle and severe acute respiratory syndrome (Sars) is a threat to Asian growth.
Stanlib's offshore performance has at least outperformed its 60:40 international equity:bond benchmark by holding 48% on long equity and more than 25% in hedge funds, including long/short equity funds.
The current market has favoured Metropolitan Asset Managers (Metam). It still has the poorest performance of the large managers over three years, but has been the top performer for the first four months of the year.
Metam chief investment officer Asief Mohamed attributes this to a low equity exposure that fell to 48%. In July last year, Metam had hedged 15% of the equity portfolio, which protected performance as the market fell even more than Metam had expected.
Metam was underweight in bonds in its global fund, but it compensated for this with a 12% holding in property.
The underweight position in gold, which hurt Metam last year, has been a strong contributor to relative performance so far this year, and the low 13% in international assets also helped.
It is probably too early to consider moving assets to Metam, but if the performance turnaround started in August is maintained until the end of the third quarter, it could start receiving inflows.
The high gold exposure in Allan Gray has hurt the house in the short term, along with its overall high equity exposure. Up to the end of April, Allan Gray and fellow value-manager Prudential are at the bottom of the LMW for the year to date, but few would be foolish enough to assume that underperformance from either manager will become a permanent feature.
Among the heavyweights, RMB Asset Management has been enjoying the strongest run so far this year. It is top of the domestic-only LMW in the year to date and second on the global survey.
RMB chief investment officer Charles Booth says the house has worked on the thesis that the rand will get stronger and it has been underweight in resources, as well as in rand hedges such as Richemont.
It has been more cautious on equities than its competitors, but Booth says when the rand hit R7,03/US$, RMB began cautiously buying a few exporters and resource counters.
RMB is often considered a bond house, but the stock selection of its equity team has been the main source of outperformance. As with most managers, RMB did not anticipate the strength of the bond market, but more recently it has been buying in the short to middle-of-the-yield curve, which is starting to look more attractive than cash.
Perennial laggard Sanlam Investment Management (SIM) is showing the first signs of a turnaround and it has taken fifth place in the year to date in the global LMW. Chief investment officer George Howard says trade has been higher than average as SIM restructures around its new Pragmatic Value style. Howard says bets have been increased, so the best ideas can make a greater performance contribution. In particular, SIM reduced its resources exposure, especially in gold, platinum and Sasol, though it has kept a full weighting in Anglo and Billiton.
SIM read the bond market better than its competitors because it was aggressively positioned at the long end of the spectrum. But its international performance was disappointing because it had about two-thirds of foreign assets in equities, which underperformed bond, cash and hedge funds.
Coronation is the only large manager that does not hold significant long international equities and its reliance on international hedge funds has been a big contributor to the strong performance of its global balanced portfolios, even at times when its domestic equity performance has been suboptimal.
But more recently it has performed equally well in the domestic and global surveys and it has been third in both in the year to date.
Coronation relative (balanced) team head Morné Marais says the improved domestic equity performance is reflected in the High Growth unit trust, which is running eighth out of 56 general equity funds over six months.
Marais says much will depend on the direction of the rand. He is still expecting the rand to end the year at R8-R8,50 and, as resource shares are fairly priced on this assumption, he is not accumulating them yet. However, if it becomes clear that the rand is heading towards R9 to the dollar, Coronation will review this.
