angles & perspectives - PSG

ANGLES & PERSPECTIVES FIRST QUARTER 2017

Contents

1. Introduction – Anet Ahern

1

2. The goose that lays the golden eggs – opportunities in quality smaller companies – Shaun le Roux

2

3. Finding value and avoiding landmines in the corporate credit market – Tyron Green

4

4. Being stewards of our clients’ capital requires responsible marketing – Anet Ahern

6

5. The PSG Balanced Fund: a robust home for pension savings – Paul Bosman

9

6. Portfolio holdings as at 31 March 2017

14

7. Percentage annualised performance to 31 March 2017 (net of fees)

17

8. Risk/return profile

18

9. Unit trust summary

19

10. Contact information

20

Investors who stay invested over the long term are rewarded for their patience.

Introduction

Anet Ahern

Anet has 30 years’ experience in investment and business management. After starting her career at Allan Gray in 1986, where she fulfilled various roles in trading and investment management, she worked as a portfolio manager at Syfrets, and later BoE Asset Management, where she was CIO and CEO. She also spent six years at Sanlam, where she was the CEO of Sanlam Multi Manager International, with assets totalling R100 billion in local and global mandates. Anet joined PSG Asset Management as CEO in 2013.

‘Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.’ Paul Samuelson

We continue to find promising long-term opportunities in global and local markets In our recent roadshow presentations, we emphasised the need to avoid black and white thinking, the importance of diversification, the value of cash, and the benefit of taking a longer-term view. Many of the opportunities we have included in our range of funds have unlocked value over the past year. By sticking to these investment principles, we continue to find attractive long-term investments in the local and global equity markets in particular, as well as in the local fixed income space. We are, as always, happy to sit in hard-working cash that delivers yields above inflation while we wait patiently for investment opportunities that meet all our requirements. Patience and thorough research help us identify the golden nuggets in the market Shaun le Roux opens this edition with a discussion about the attraction of smaller companies. Investing in smaller companies as part of a diversified portfolio that also holds larger global and local companies as well as fixed income assets where mandates allow, fits in well with our research-driven, long-term approach. Shaun refers to these companies as ‘gold nuggets’, which we only find if we practise patience and do our homework properly. Unlocking the value of cash in a portfolio requires painstaking research Tyron Green from our credit team highlights the potential pitfalls and opportunities in the corporate credit market. Cash, which includes money market and credit instruments, plays an important role in our multi asset portfolios. In addition to providing a yield above inflation, it provides a buffer against market volatility. Most importantly, it enables us to take advantage of opportunities created by unexpected market events and changes in sentiment, which we suspect we will continue to see more of.

However, cash can only fulfil this role on a sustained basis if we do proper research on the borrowers upfront to ensure we are entrusting our clients’ money to quality borrowers. Our credit process has turned us away from several seemingly attractive propositions because we could not be absolutely sure of the risks attached to the decision. Painstaking analysis of every credit opportunity is our credit team’s bread and butter. Responsible marketing is essential to help investors benefit from rewarding opportunities The past year has once again illustrated how investor behaviour can lead to the destruction of wealth. In our article on responsible marketing we demonstrate why this happens, and share our thoughts on how responsible marketing efforts that focus on more than investment performance can help investors make better decisions. Learn more about why the PSG Balanced Fund is ideal for saving for retirement Our featured portfolio this quarter is the PSG Balanced Fund, which is part of our Regulation 28 offering and an ideal portfolio for retirement savings. This portfolio has recently received a Raging Bull award for the best risk-adjusted returns over five years in the South African Multi Asset High Equity category. A consistent, long-term approach will stand investors in good stead despite ongoing uncertainty Times remain uncertain. We believe that investors’ best allies in the current market environment are a well-considered longterm financial plan, a partnership with asset managers who stick to their proven processes, and a good deal of patience. We trust that you will find our writings insightful and welcome your feedback. Thank you for your interest and support.

FIRST QUARTER 2017 | 1

The goose that lays the golden eggs – opportunities in quality smaller companies

Shaun le Roux

Shaun has managed the PSG Equity Fund since 2002 and he is also Co-Fund Manager of the PSG Flexible Fund. He has won numerous awards, including four Raging Bull awards and two Standard & Poor’s awards. Shaun is a CA(SA) and a CFA charterholder.

Finding the golden goose can save you a lot of time and effort (and disappointment) Contrarian value investing can be likened to sifting through a field of pebbles hoping to find that discarded nugget of gold. Sometimes you spend a long time looking and come up emptyhanded, and sometimes the nuggets are plentiful. However, you can secure the richest pickings and save yourself all that effort if you find the goose that lays the golden eggs. Golden geese often take the form of high-quality smaller companies that are mispriced Within equity markets, the golden goose is the stock that keeps on giving to the investor. This refers to investments that compound investor returns over long periods of time, making a significant contribution to portfolio returns. We have found that golden geese are much more prevalent among the neglected smaller listed companies than among the popular blue chip large caps. We think there are structural reasons why these businesses are overlooked and mispriced by many market participants. The pain of regret – missing that ten-bagger Every investor has regrets. One of the most common forms of regret is the ten-bagger or golden goose you either passed over entirely or sold when it was merely a three-bagger. In these cases, it is uncomfortable to watch the share prices of the likes of Capitec, Famous Brands or EOH climb year after year as the company’s profit compounds. Our clients have owned all three of these shares in the past (and still own EOH today). They have enjoyed the significant benefit that comes from being invested in exceptional smaller companies over long periods of time – particularly when we were able to buy the shares at a very cheap price in times of fear and uncertainty. However, we have also made plenty of mistakes along the way. Regrettably, we have on occasion underestimated the inherent compounding ability of some of our top performers and sold or reduced our exposure too soon. This was definitely the case for Famous Brands and EOH. Selected smaller companies can provide a structural advantage We invest across the size spectrum for our clients and are not primarily small or mid cap investors. We do, however, believe that there are a number of reasons why investing in carefully selected smaller companies can provide a structural advantage to an equity portfolio. We prefer as wide an investment universe as possible. This is why we invest globally and are happy to invest outside the Top 40 companies listed on the JSE. A small group of names dominate the JSE indices and a handful of managers are responsible

2|

for the lion’s share of the South African asset management industry’s assets. As a result, the average South African equity portfolio is very heavily weighted to a small number of mega cap shares. In reality, it is very difficult for a large manager to extract value for their clients by investing outside of the Top 40, because their funds are too big. For example, a manager that has R200 billion invested in South African equities can only invest in 26 companies on the JSE, assuming that they want the stock to make up 2% of their portfolios and would prefer to own no more than 10% of the company – and this is before allowing for the free float in a share. As a result, the true investment universe under these criteria is even smaller. The focus on large companies makes the mispricing of smaller companies more likely It is clear to us that the absence of size constraints when coupled with an ability to select investments from outside the Top 40 presents a significant competitive advantage for domestic equity managers. Since the largest players who dominate the local asset management industry are focused on the large caps, it should come as no surprise that the sell-side analysts that service them also focus on the large caps. As a result, there is very little research on smaller companies and many are neglected, as shown in Graph 1. In this environment mispricing is more likely. Smaller companies can offer significant compounding benefits The real advantage that smaller companies can bring to a portfolio is that they can compound at high rates for long periods of time, as shown in Table 1. The business may be operating in a fast-growing industry or could be enjoying rapid growth in market share, or both. Large cap names are typically more mature businesses, often competing in more mature industries. As a result, medium-term growth rates will be more muted. Smaller companies can be more volatile, so you must do your homework and take a long-term view A feature of investments in smaller businesses is that they are less liquid. Share prices can therefore be prone to swings in investor sentiment between fear and greed. At times liquidity can just about disappear, as it did in 2008. To some investors this volatility is more than they can stomach. In addition, this perception of risk is exacerbated by the fact that most smaller businesses on the JSE are heavily exposed to the domestic economy, which is susceptible to global economic sentiment, domestic politics and movements in the rand. The attraction for long-term investors is that this perception of risk results in material mispricings from time to time, which can be exploited.

Graph 1: Average number of analysts covering Top 40 stocks versus smaller companies 14

13

12 10 8 5

6 4 2

Smaller company index

FTSE/JSE Top 40 Index

Sources: PSG Asset Management, Bloomberg Note: The smaller company index is a combination of the FTSE/JSE Mid Cap Index and the 15 largest equities included in the FTSE/JSE Small Cap Index.

Table 1: Total returns of mid cap versus Top 40 stocks (2002 - 2016) Total return FTSE/JSE Mid Cap Index

Annualised 910.3%

16.7%

FTSE/JSE Top 40 Index

358.1%

10.7%

Difference

552.2%

6.0%

Sources: PSG Asset Management, Bloomberg

For these reasons, it can be more difficult to get in and out of smaller stocks and they can be prone to large price moves. That is why you need to do your homework, perform a detailed assessment of the inherent quality of the business, and patiently wait for mispricings to be corrected and compounding to work its magic. The quality of management is very important when investing in less liquid stocks. We prefer to invest only in businesses with strong management teams that have a track record of looking after minority shareholders. The current divergences in stock valuations present both risks and opportunities There are currently many good opportunities to earn excellent long-term returns on the JSE, in many cases from outside the Top 40. For some time, the stockmarket has been characterised by a significant difference in the valuations of stocks that are perceived to be of a high quality and stocks that are more cyclical in nature. In the case of the former, we would argue that investors are focusing on a positive narrative and are extrapolating past experience, paying very little attention to the price paid. For example, there is currently strong demand for private education groups and food producers. Investors will be hoping that the companies deliver on the very lofty

expectations that are built into their share prices. At PSG Asset Management, however, we are focusing on the out-of-favour domestic companies that are exposed to the tougher parts of the economy and have a greater chance of being mispriced. These include the likes of Super Group, Tongaat and Hudaco. We have typically owned these businesses for many years but have increased our exposure as the margin of safety widened. We have found that buying good businesses very cheaply when earnings are depressed can be the recipe for excellent longterm returns. We continue to look for golden geese that are not overpriced Investing in smaller cap companies is not for everyone – it can be a rocky ride. Golden geese are often only obvious with hindsight and markets tend to eventually price lofty expectations into businesses with excellent, established track records. However, the way the market is structured often results in high-quality businesses being neglected and mispriced, providing the opportunity to earn superior long-term returns. Our clients have benefited tremendously in the past from their long-term investments in high-quality smaller companies. We continue to actively seek out such opportunities.


Finding value and avoiding landmines in the corporate credit market

Tyron Green

Tyron has seven years’ experience in the investment industry. He joined the fixed income team as a Credit Analyst in 2013, is Co-Fund Manager of the PSG Income Fund and serves on the PSG Asset Management Credit Investment Committee.

Negative asymmetry – a challenge for the prudent investor Investing in bonds can be a challenge for the prudent investor. If you hold a bond to maturity, the upside return is known and limited to the yield on the security. The downside can be multiples of the potential yield, and in a worst-case scenario, you could lose all your capital. This is often referred to as negative asymmetry. Bond investors therefore need to carefully assess the likelihood of not getting all of their capital back and whether the yield on the security is sufficient compensation for the inherent risk. The PSG Asset Management philosophy lends itself well to investing in credit markets We always invest with a margin of safety and are prepared to patiently wait for securities to be attractively priced. When opportunities arise, they are often very promising and can deliver great returns for investors at relatively low levels of risk. Investors must also do their own homework and always read the fine print. In addition, they must have the courage to walk away from an opportunity if there is insufficient information to assess the risk of loss or insufficient returns to compensate for perceived risks. There is significant overlap between investing in credit and equity markets. Both require a very careful assessment of a company’s financial strength and sustainable earnings power. We have found over time that our clients have benefited tremendously from separately analysing a company’s debt and equity issuances. As a result, we have avoided investing in some over-indebted businesses that have not been sufficiently capitalised. Some of our better investments have also come in times of distress and panic. This is when we have found that a careful examination of the true strength of a corporate balance sheet has indicated a wide margin of safety for an equity or credit investment. A good recent example is Glencore, when the combination of our credit and equity analysis indicated a very attractive opportunity in the midst of the 2015 commodity crisis. Bond markets provide promising opportunities from time to time Our investors will know that we like to find ideas in areas where there is a significant chance that securities will be mispriced. These opportunities often arise when investors become forced sellers or when their decisions are motivated by reasons other than getting a good price for the security. In these circumstances, the odds of getting a good bargain are high. Credit markets provide these opportunities from time to time. For evidence of this, we need to look no further than famed investor Howard Marks from Oaktree Capital. He has built a $100 billion credit investment firm, with much of the company’s track record rooted in investing in distressed securities.

4|

Mispricings in the credit market offer valuable opportunities – the Capitec example The fixed income markets don’t offer significant mispricing often, but when they do, we act. One of the better opportunities for our clients in recent times was Capitec in 2014. We took the time to understand the business through our 3M process, became familiar with the risks, and developed our internal credit rating and required return. When African Bank (ABIL) collapsed, we saw forced sellers of Capitec bonds (following the downgrade of Capitec’s credit rating) and a blow-out in yields. We were able to lock in very attractive yields at a wide margin of safety and were aggressive buyers of Capitec paper for our clients. Our funds had no ABIL exposure at the time – we considered the balance sheet undercapitalised and the yields materially insufficient to compensate for the risk. Although Capitec’s yields are lower today, our clients still own Capitec credit. We continue to avoid ABIL bonds, despite their seemingly attractive yields, for the following reasons: • Their provisioning policy remains aggressive when compared to Capitec. • Their funding cost is much higher – Capitec has a significant retail deposit base that provides ‘cheap’ funding. • The bank still requires significant information technology spend. • We have not seen evidence of their ability to sustainably grow their loan book (without increasing non-performing loans). Current credit market opportunities – we see value in senior unsecured bank debt Due to all the negative news around domestic banks, the sovereign rating downgrade and ABIL’s collapse, banks have been issuing debt at much wider spreads. This is despite the fact that they have significantly bolstered their balance sheets and are currently very well capitalised. After the recent sovereign and bank downgrades by Fitch and Standard & Poor's Global Ratings (S&P), we have seen bank spreads widen marginally by a few basis points in secondary trades, reflecting that much of the news had been already priced in. This has allowed investors to invest at a better price at lower levels of risk. We have taken advantage of this compelling investment opportunity. The market seems to have become aware of this opportunity, and with the issuance of corporate bonds on the decline, bank issuance spreads have already started to tighten. Graph 1 shows the three-year senior unsecured issuance spreads of the big five banks since 2008. The graph shows that recent spread levels have been close to the levels seen during the 2008/2009 global financial crisis. However, the banks now have much stronger balance sheets with lower credit losses, improved provisioning, higher regulatory capital and liquidity requirements, and higher capital adequacy ratios.

Graph 1: Three-year senior unsecured issuance spreads of the big five banks (2008 - 2017) 2.3 2.1 1.9 1.7 1.5 1.3 1.1 0.9 0.7 0.5 FEB '08

JUL '09

NOV '10 Bank 1

APR '12 Bank 2

AUG '13 Bank 3

DEC '14 Bank 4

MAY '16

SEP '17

Bank 5

Source: PSG Asset Management

New additional tier 1 bank bonds, on the other hand, don’t offer a favourable risk/return trade-off While we see value in senior unsecured debt, not the same can be said for all bank bonds. The banks introduced a new bond into the market in 2016, namely additional tier 1 (AT1) bonds, whose characteristics are similar to equity. The new bonds are the most subordinated debt instruments, and on a default, they will rank ahead of equity based on the current resolution framework. However, according to the legal terms (until the new resolution framework is finalised) these bonds will be written off if certain capital adequacy ratio triggers are reached. This means that, by their legal nature, the bonds will be written off on a going concern basis, while equity shareholders may survive. In addition, the bonds offer a lower return than the cost of equity and are less liquid than equity. We would be cautious of owning these instruments in a fixed income portfolio, particularly a low-risk income fund. Bonds with insufficient information to assess the impact of corporate actions Other than for the banks, corporate bond issuance has been low in recent times. As a result, there is a worrying trend developing. We have found that investors are participating in auctions and owning bonds where there is little or no information available on a significant part of the issuer business. In a recent example from August last year, a mid to large cap industrial company announced a large acquisition of around 25% of the company’s market capitalisation. The company

funded the acquisition through a clawback offer to equity holders, private and public bond issuances, and bank funding. This meant that they did not have to issue a detailed circular on what they were acquiring. The equity and public bond holders therefore received limited information about the intended corporate action, and subsequent detail on the impact on the business has also not been forthcoming. Yet the company had no trouble placing bonds, even with limited information. Furthermore, yields on this company’s bonds are trading at very low levels relative to history, despite the lack of information around a material acquisition. We require detailed relevant information to assess the risk of not getting our capital back. If that is not available, we will not be investing. We will continue to invest in a prudent manner We have seen bank and corporate spreads widen and will continue to invest where we see value at appropriate levels of risk. There is also a great deal of uncertainty with respect to local and global political and economic conditions. This will give rise to volatility and from time to time the market can be expected to act irrationally. We currently have high levels of cash in our multi asset funds and will wait patiently for the right opportunities. However, clients can expect us to pounce to deploy this cash when these opportunities arise.


Being stewards of our clients’ capital requires responsible marketing

Anet Ahern

Anet has 30 years’ experience in investment and business management. After starting her career at Allan Gray in 1986, where she fulfilled various roles in trading and investment management, she worked as a portfolio manager at Syfrets, and later BoE Asset Management, where she was CIO and CEO. She also spent six years at Sanlam, where she was the CEO of Sanlam Multi Manager International, with assets totalling R100 billion in local and global mandates. Anet joined PSG Asset Management as CEO in 2013.

Discounting emotion when making important decisions is not a natural human tendency Many years ago, when stress management breakaways were popular, I attended a session that sparked a hot debate. Our group was presented with a scenario with the aim of determining what constitutes moral behaviour. In the story, a young woman was separated from her injured husband by a wide, deep river. She could not afford to pay the passage to get to him and it was too dangerous to swim. A boatsman offered her safe passage to be reunited with husband. However, for payment, she had to betray her husband. The question posed to us was: if the woman accepted, who would be behaving immorally – the woman or the boatsman? Initially, cries of outrage towards the boatsman drowned out any rational discussion. When these died down, some participants made the counter argument: the woman is an adult, she has freedom of choice, and she knows the consequences of her decisions. The boatsman merely made his price. He is, after all, a businessman. The heated protest following this claimed that he was exploiting his position and was making the woman’s already difficult predicament even worse. Needless to say, the group didn’t reach an agreement, except for agreeing that it was very difficult to keep their emotions at bay in trying to come to a conclusion. Investor behaviour is often one of the biggest threats to successful investment outcomes For the average investor, regulations in South Africa have led to much better disclosure of fees and charges, risk profiles, mandates and other aspects of investment products. Buyers can see what is in the tin, and they know what they are being charged for. However, beyond that, there is still a wide range of possible future outcomes flowing from their decisions. Often their own behaviour poses a significant risk to the result. The stress of the young woman’s situation tainted her ability to make a rational decision and placed her in a position to be exploited. Similarly, the average investor is in a vulnerable position. There is a constant tension between the need to save for retirement and dealing with growing daily demands on discretionary savings. In addition, investors are having to deal with this tension in an environment characterised by ongoing volatility that threatens to derail what was supposed to be a smooth journey to a comfortable retirement.

6|

External market and media influences make sensible investment decisions even harder In past editions, we have written about how the market is configured to encourage investors to buy high and sell low, and the effort and discomfort it takes to do the opposite. As if that is not enough of an obstacle, investors are also bombarded with marketing messages that encourage the same dysfunctional investment behaviour. A focus on short-term performance is a key factor preventing investors from reaching their goals We take our role as stewards of our investors’ savings very seriously. We take a long-term view, make sure we are diligent in our research, and always aim to build a margin of safety into all our investment decisions. But is this enough? We don’t think so. Ultimately, the most satisfied investor is the one whose expectations are met. Let’s assume an investor requires a return of 5% above inflation. Graphs 1 and 2 show two different approaches to achieve this and two outcomes. In the scenario for Graph 1, the investor puts an equal amount of money into portfolio A and portfolio B. The result comfortably beats the target, despite both portfolios going through patches of short-term underperformance. In Graph 2, the investor switched from one portfolio to the other after a period of underperformance. This involved switching out of the underperforming portfolio into the outperforming one. The result, which does not even include the impact of tax, is a lot less satisfactory. In the second scenario, the investor may have responded to marketing messages that emphasised shortterm performance, encouraging the investor to invest in the best short-term performer. Examples of how messages of fear destroy value are plentiful There are many examples of wealth-destroying behaviour during volatile times that is driven by marketing messages creating fear. For example, the capital flight into offshore investments early last year when the rand weakened dramatically was accompanied by aggressive advertising for these products. However, investors who switched out of then-underperforming local equity funds into offshore accounts ended up being worse off. Although their local investment initially fell, prompting them to take their money offshore, their offshore investment suffered when the rand recovered. In the meantime, the investment they sold out of performed well, keeping its long-term track record intact and delivering on its promise.

Graph 1: Investment outcomes when staying invested despite short-term underperformance R200 000 R190 000 R180 000

Investment value

R170 000 R160 000 R150 000 R140 000 R130 000 R120 000 R110 000 R100 000 2012

2013

2014

Portfolio A (PSG Balanced)

2015 Portfolio B (Peer portfolio)

2016

2017

SA CPI+5%

Portfolio A and Portfolio B Sources: Morningstar Inc, PSG Asset Management

Graph 2: Investment outcomes when switching investments based on short-term performance R200 000 R190 000 Disinvest from Portfolio B, buy Portfolio A

R180 000

Investment value

R170 000 R160 000 R150 000

Disinvest from Portfolio A, buy Portfolio B

R140 000 R130 000 R120 000 R110 000 R100 000 2012

2013

2014

Portfolio A (PSG Balanced)

2015 Portfolio B (Peer portfolio)

2016

2017

Switching portfolios

Sources: Morningstar Inc, PSG Asset Management FIRST QUARTER 2017 | 7

Responsible investment marketing can go a long way in improving investment outcomes We believe that responsible marketing can make a real contribution to better outcomes for investors by helping them to: • prevent unnecessary switches, • take a longer-term view and stick to their strategy, • stomach shorter-term underperformance, which is often inconsequential in the long run, • understand how their fund manager’s approach works in practice so that they can make a better selection of funds from the start, and • stick with a diversified approach based on an understanding that certain parts of their portfolio will lag from time to time, but that other parts can compensate for this underperformance.

As stewards of our clients’ capital, investor outcomes should be a key priority As was the case with the young woman and the boatsman, investors are grownups with free choice and marketers can put their proposition forward in the way they want to. However, this does not justify exploiting the situation. We believe irresponsible marketing, even if it measures up to industry regulations and guidelines, contradicts the spirit of acting as stewards of investors’ savings.

In sharing our view of what responsible marketing is, it also helps to clarify what we think is it not, as summarised in Table 1.

Aligning clients’ understanding of the investment approach with that of the team behind the portfolio, as well as managing expectations, can help to bring investor outcomes and portfolio performance closer together.

Investment marketing messages deserve as much thought, consideration and consistency as the investment process, and should be aligned with the investment process. We need to be as serious about improving the outcome for individual investors as we are about the actual performance of the portfolios. Sadly, the two are often far apart.

Table 1: Our views on responsible investment marketing What responsible marketing should be

What responsible marketing is not

• Helping investors understand how the manager makes

• Focusing on short-term performance in any way, even if the

•

• Aggressively marketing products that are responding to

• • •

investment decisions Affirming the consistency with which the manager applies the investment approach and responds to the investment environment Being consistent about how the message relates to the time horizon and risk profile of the product Being clear about what investors can expect from the product Making it easy for investors to determine whether the type of product will suit their time horizon, risk profile and temperament

Source: PSG Asset Management

8|

industry rules are adhered to

current market upheaval, such as a sudden drop in an index or a sharp currency depreciation • Messaging that feeds off fear in any way, including the ‘fear of missing out’ (FOMO)

Paul Bosman

The PSG Balanced Fund: a robust home for pension savings

Paul is the Co-Fund Manager of the PSG Balanced, PSG Stable, PSG Flexible and PSG Diversified Income funds. Paul joined the PSG Tanzanite team in 2004 as an Equity Analyst. He became a Fund Manager at PSG Asset Management in 2011.

Where to save for retirement is just as important as how much to save When you hand in your access card at the end of your last day of work, will you be thinking about all your travel opportunities or about pensioner specials? This is a function of not only how much you put away every month, but also a function of where you have been investing those savings. Consider the following scenario: if an investor invests R5 000 per month for 40 years in a portfolio that returns 9% per year, the investor will retire with R4.3 million. However, if the investor invested in a portfolio that returns 14% per year, the investor will retire with R13.8 million. (We have assumed contributions grow by inflation and have discounted the total sum to represent value in current terms.) Clearly, choosing a portfolio for your retirement savings is one of the most important decisions of your life. But how much time do investors spend on this? The contradiction of cash as a ‘safe’ haven Uncertainty causes risk aversion, which results in investors migrating to cash and other low-risk instruments. While this is natural and understandable, it can have a profoundly negative long-term impact. When saving for retirement, the time horizon is long, and exposure to so-called high-risk asset classes, such as equities and corporate bonds, is the only way investors can protect and grow their money in real terms. If they hide in cash, or even low-risk, low-return funds, they will retire to pensioner specials. The PSG Balanced Fund is suitable for long-term savings as it invests sufficiently in equities and bonds to avoid this low-risk, low-return trap. It has returned 14.7% per year since its inception in June 1999. Although past returns are no guarantee of future returns, we maintain the investment philosophy that generated very satisfactory returns for our clients in the past. There are certain key principles that underpin how we manage clients’ pension savings So how do we go about executing on this tremendous responsibility of managing our clients’ pension savings? We consistently apply three principles: 1. We buy securities with an inherent quality (moat and management). 2. We try to never pay more for a security than it is worth (margin of safety). 3. We diversify across industries, asset classes and geographies. We have often written about the first two principles. In this article, we want to delve deeper into the third principle. How do we decide which industries to invest in? There are two ways in which an investor can access a specific industry: equity exposure or bond exposure. Our exposure to any specific industry is a function of how many opportunities we

identify through our bottom-up process. Our industry exposure is therefore the result of where we are finding undervalued opportunities, rather than a strategic top-down decision. However, we do monitor correlations within the portfolio and will always ensure that there is no extreme exposure to any one industry. This is especially true of industries that have poor economic track records. How do we decide how much of each asset class to hold? The PSG Balanced Fund may not invest more than 75% in equities, but there is still significant leeway left to the manager. How do we make this very important decision on behalf of the client? We follow a bottom-up asset allocation process, which is consistent with our philosophy. Consider Graph 1. Required rate of return is just another way of expressing required margin of safety. A lower security price implies a higher return or yield. We determine a required return for each individual security, based on the company’s moat, management and balance sheet strength. Securities that offer a rate of return in excess of our required rate will be added to our portfolios. The more the return exceeds our required return, the greater the exposure to the security. The fewer opportunities there are, the greater the portfolios’ allocation to cash. This process is therefore what determines the asset allocation of our portfolios, rather than a strategic (or ‘top-down’) view on a perasset-class basis. How do we decide which portion of the portfolio to invest offshore? The PSG Balanced Fund can have a maximum direct offshore exposure of 25%. We tend to run at or very close to the maximum allocation. There are two key reasons for this: 1. We reduce the risk of having all the eggs in one basket, namely in rand-denominated assets. 2. The universe of compelling investment opportunities is tremendous. How do we decide which geographies to target? Again, this is a function of where we find the most 3M opportunities. However, we generally have a preference for developed markets, since the other 75% of the portfolio is all in one emerging market. Our bottom-up process determines the composition of the PSG Balanced Fund Figure 1 is a graphic representation of how our thorough bottom-up process feeds into the PSG Balanced Fund and ultimately determines the composition of the portfolio.


Graph 1: Our required rate of return versus long-term inflation expectations

Return

PSG Asset Management required rate of return

Long-term inflation expectations

Cash

Short-term credit

Medium-term bonds

Longer bonds

Property

Equities

Maturity Source: PSG Asset Management

Figure 1: Our multi asset investment process Multi asset portfolios

Portfolio managers consider all opportunities on a risk/return basis

Equity buy list

Equity Investment Committee

Buy lists are calibrated for level of conviction Fixed income buy list

Fixed Income Investment Committee

Thorough bottom-up research

PSG Asset Management investment philosophy (3Ms) Source: PSG Asset Management

10 |

Credit buy list

Credit Investment Committee

Avoiding common investment traps is also part of our investment process Two of the biggest traps when making investment decisions is to become overconfident and/or chase returns relative to peers. How do we steer clear of these traps? • Avoiding overconfidence We don’t take a position without doing very thorough research and having rigorous debate. We also monitor total portfolio correlations, and don’t ‘swing for the fences’. • Not chasing peers Our entire process is configured around generating real returns. Position sizes are driven by both the probability of a specific security returning in excess of our hurdle return and the extent to which it can exceed the return. We remain focused on this process rather than what our peers are holding. We are not prepared to buy overvalued securities to mitigate the risk of relative underperformance, as this is not in the interest of our clients.

The long-term outperformance of the PSG Balanced Fund proves the success of our process Since we don’t focus on peer returns, any outperformance is purely the result of our process. Long-term outperformance of peers is therefore an indication of a process that is able to generate handsome returns – and long-term outperformance is exactly what the PSG Balanced Fund has achieved in the past. The portfolio was named the top risk-adjusted performer in the South African Multi Asset High Equity category at the recent 21st annual Raging Bull Awards. It was also named the Best Aggressive Allocation Fund at the recent Morningstar Awards. In conclusion, we strongly encourage investors to take some time to think about their pension fund savings and to understand the long-term cost of low-risk investments and/or poor portfolio choices. It will be worth every minute – many times over.


Notes

12 |

Notes


Portfolio holdings as at 31 March 2017

PSG Equity Fund

PSG Flexible Fund

PSG Balanced Fund

Top 10 equities

Top 10 equities

Top 10 equities

Discovery Holdings Ltd Old Mutual plc Glencore plc Super Group Ltd Brookfield Asset Management Inc FirstRand Ltd Tongaat-Hulett Ltd J Sainsbury plc Hudaco Industries Ltd Grindrod Ltd

Discovery Holdings Ltd Old Mutual plc Brookfield Asset Management Inc J Sainsbury plc FirstRand Ltd Glencore plc Super Group Ltd Cisco Systems Inc Grindrod Ltd Tongaat-Hulett Ltd

Brookfield Asset Management Inc Discovery Holdings Ltd FirstRand Ltd Old Mutual plc Nedbank Group Ltd Glencore plc Hudaco Industries Ltd Super Group Ltd AIA Group Ltd J Sainsbury plc

Asset allocation

Asset allocation

Asset allocation

• Domestic resources 11%

• Domestic resources 6%

• Domestic resources

• Domestic financials

29%


20%


17%

• Domestic industrials

35%


23%


18%

• Domestic cash and NCDs

27%


12%

• Foreign equity

21%

• Domestic bonds

24%

• Foreign equity

22%

• Domestic cash and NCDs • Foreign equity

1% 23%

• Foreign cash

1%

Total 100%

• Foreign cash

3%

Total 100%

4%

• Foreign cash

3%

Total 100%

Performance

Performance

1 400

800

1 200

1 200

700

1 000

1 000

600

800

500

600

400

400

300

200

200

0

'03

'05

'07

PSG Equity Fund

14 |

'09

'11

'13

'15

'17

FTSE/JSE All Share TR Index ZAR

100

Performance

800 600 400 200 '05

'07

'09

PSG Flexible Fund

'11

'13

'15

Inflation +6%

'17

0

'01

'03

'05

'07

'09

PSG Balanced Fund

'11

'13

'15

Inflation +5%

'17

PSG Stable Fund

PSG Diversified Income Fund

PSG Income Fund

Top 5 equities

Top 5 equities

Top 10 exposures

Discovery Holdings Ltd Brookfield Asset Management Inc FirstRand Ltd Nedbank Group Ltd Old Mutual plc

Discovery Holdings Ltd Brookfield Asset Management Inc Nedbank Group Ltd FirstRand Ltd J Sainsbury plc

Top 5 issuer exposures


Republic of South Africa Absa Bank Ltd FirstRand Bank Ltd Nedbank Ltd Capitec Bank Ltd

Republic of South Africa Absa Bank Ltd Standard Bank of SA Ltd Nedbank Ltd FirstRand Bank Ltd

Absa Bank Ltd Standard Bank of SA Ltd Nedbank Ltd Republic of South Africa FirstRand Bank Ltd PSG Money Market Capitec Bank Ltd Imperial Group Ltd The Thekwini Fund (RF) Ltd Investec Bank Ltd

Asset allocation

Asset allocation


Asset allocation

10%



11%



25%


36%

• Domestic cash and NCDs 7%

• Domestic bonds

36%

• Domestic bonds

53%

Total 100%

• Foreign equity

14%

• Foreign equity

4%

• Foreign cash

2%

• Foreign cash

4%

4%

• Fixed rate notes

58%

1%

• Floating rate notes

35%

Total 100%

Total 100%

Performance

Performance

Performance

200

250

160

180

140

200

160

120

140

150

120 100

100

100

80

80 60

'11

'12

'13

PSG Stable Fund

'14

'15

'16

'17

Inflation +3% over a rolling 3-year period

50

'06

'07

'08 '09

'10 '11 '12 '13 '14


'15 '16 '17 Inflation +1%

60

'11

'12

'13

PSG Income Fund

'14

'15

'16

'17

STeFI Composite Index (ZAR)


PSG Money Market Fund

PSG Global Equity Sub-Fund

PSG Global Flexible Sub-Fund


Top 10 equities

Top 10 equities

Absa Bank Ltd Nedbank Ltd Standard Bank of SA Ltd FirstRand Bank Ltd Investec Bank Ltd Land and Agricultural Development Bank of SA Netcare Ltd Capitec Bank Ltd Republic of South Africa Kap Industrial Holdings Ltd

Brookfield Asset Management Inc J Sainsbury plc Cisco Systems Inc Yahoo Japan Corp Berkshire Hathaway Inc Glencore plc AIA Group Ltd Colfax Corp Union Pacific Corp JPMorgan Chase & Co

Brookfield Asset Management Inc J Sainsbury plc Cisco Systems Inc Berkshire Hathaway Inc Yahoo Japan Corp AIA Group Ltd Glencore plc Colfax Corp JPMorgan Chase & Co Union Pacific Corp

Asset allocation

Regional allocation

Regional allocation

• Linked NCDs/Floating rate notes 26%

• US 44%

• US 35%

• Step rate notes

9%

• Europe 3%

• Europe 2%

• NCDs 54%

• UK 16%

• UK 13%

• Corporate paper

2%

• Asia 13%

• Asia 11%

• Bill 1%

• Canada 8%

• Canada 7%

• Call 8%

• Singapore 1%

• Singapore 1%

Total 100%

• Africa 2%

• Africa 1%

• Cash 13%

• Cash 30%

Total 100%

Total 100%

Performance

Performance

Performance

500

200

140

180

120

160

100

300

140

80

200

120

60

100

40

400

100 0

'01

'03

'05

'07


16 |

20

80 '09

'11

'13

'15

'17

(ASISA) South African IB Money Market Mean (Benchmark)

60

'10

'11

'12

'13

PSG Global Equity Sub-Fund

'14

'15

'16

'17

MSCI Daily Total Return Net World USD Index

0

'13

'14

'15

PSG Global Flexible Sub-Fund

'16

'17

US Inflation +6% USD

Percentage annualised performance to 31 March 2017 (net of fees) Local funds PSG Equity Fund A FTSE/JSE All Share Total Return Index PSG Flexible Fund A

1 Year

2 Years

3 Years

5 Years

10 Years

Inception

Inception date

18.74

6.98

9.37

17.06

10.93

18.93

01/03/2002

2.54

2.85

5.98

12.50

9.82

14.35

11.80

8.82

11.25

15.31

14.00

17.07

Inflation +6%

12.33

12.67

11.76

11.81

12.26

11.92

PSG Balanced Fund A

10.34

7.36

9.86

13.21

9.95

14.68

Inflation +5%

11.32

11.65

10.73

10.79

11.37

10.67

8.56

7.46

8.24

9.87

PSG Stable Fund A

10.19

Inflation +3% over a rolling 3-year period

9.31

9.65

8.73

8.79

PSG Diversified Income Fund A

8.41

8.03

7.80

8.16

7.76

Inflation +1%

7.31

7.64

6.73

6.79

7.36

PSG Income Fund A

8.73

7.83

7.44

6.46

STeFI Composite Index

7.57

7.08

6.77

6.19

PSG Money Market Fund A

7.57

7.09

6.77

6.12

7.23 7.26

South African Interest Bearing Money Market Mean

01/11/2004 01/06/1999 13/09/2011

8.73 7.90

07/04/2006

7.33 6.50

01/09/2011

6.14 8.57

19/10/1998

7.72

7.15

6.78

6.17

11.80

8.78

10.47

17.44

MSCI Daily Total Return Net World USD Index (in ZAR)

4.63

10.73

14.41

22.28

PSG Global Flexible Feeder Fund A

7.96

9.02

11.16

16.26

-0.86

13.48

16.28

18.91

1 Year

2 Years

3 Years

5 Years

Inception

Inception date

23.92

4.18

2.65

6.18

5.42

23/07/2010

MSCI Daily Total Return Net World USD Index

14.78

5.26

5.52

9.37

10.10

PSG Global Flexible Sub-Fund A

19.87

4.61

3.12

5.92

8.75

7.88

7.24

7.36

PSG Global Equity Feeder Fund A

US Inflation +6% (in ZAR)

8.57 15.01

03/05/2011

20.97 10/04/2013

International funds PSG Global Equity Sub-Fund A

US Inflation +6% (USD)

10 Years

02/01/2013

Source: 2017 Morningstar Inc. All rights reserved as at end of March 2017. Annualised performances show longer-term performance rescaled over a 12-month period. Annualised performance is the average return per year over the period. Past performance is not necessarily a guide to future performance.


PSG Stable

PSG Money Market

PSG Income

PSG Diversified Income

Risk/return profile

Anticipated long-term real returns

18 |

Average risk

PSG Balanced

PSG Global Flexible PSG Flexible

PSG Global Equity

PSG Equity


PSG Stable Fund


PSG Income Fund


Provide long-term capital growth and deliver a higher rate of return than that of the South African equity market within an acceptable risk profile

FTSE/JSE All Share Total Return Index

High

5 years +

• seek an equityfocused portfolio that has outstanding growth potential • aim to maximise potential returns within an acceptable risk profile

Investment objective

Benchmark

Risk rating

Time horizon

The Fund is suitable for investors who

Bi-annually

R2 000 lump sum, or R250 monthly debit order

Annual management fee: Class A: 1.71%

No

Income distribution

Minimum investment

Fees (incl. VAT)

Compliance with Prudential Investment Guidelines (Regulation 28)

No

Yes

Yes

Yes




Annual management fee: Class A: 1.14% + 7.98% of outperformance of high watermark


Quarterly


Bi-annually


0% - 10%

Bi-annually

0% - 40%


0% - 75%

No



Quarterly

0%

• focus on a shortto medium-term investment horizon

• want to earn an income, but need to try and beat inflation • focus on a shortto medium-term investment horizon

• have a low risk appetite with an income requirement

1 year +

Low - Moderate

STeFI Composite Index

Maximise income and preserve capital while achieving long-term capital appreciation as interest rate cycles allow

South African - Interest Bearing - Short-term

• have a low risk appetite and an income requirement

2 years +

Low - Moderate

Inflation +1%

Preserve capital and maximise income returns for investors. The fund conforms to legislation governing retirement funds

South African - Multi AssetIncome

Bi-annually

0% - 100%

• want long-term retirement savings

• want a balanced portfolio that diversifies the risk over the various asset classes

• have a time horizon of at least 3 years and can withstand short-term market fluctuations

• f ocus on a shortto medium-term investment horizon

• aim to build wealth within a moderate risk investment

• aim to build wealth

• focus on a mediumto long-term investment horizon

•h ave a low risk appetite but require capital growth in real terms

2 years +

Moderate

Inflation +3% over rolling 3-year period

Seek to generate a performance return of CPI+3% over a rolling 3-year period, while aiming to achieve capital appreciation with low volatility and low correlation to equity markets through all market cycles

South African - Multi Asset - Low Equity

• would prefer the fund manager to make the asset allocation decisions

3 years +

Moderate - High

Inflation +5%

Provide long-term capital growth and a reasonable level of income

South African - Multi Asset - High Equity

• seek exposure to the equity market but with managed risk levels

3 years +

Moderate - High

Inflation +6%

Achieve superior medium- to long-term capital growth through exposure to selected sectors of the equity, bond and money markets

South African - Multi Asset - Flexible

Yes


R25 000 lump sum

Monthly

0%

• focus on a shortto medium-term investment horizon

• need an interim investment vehicle or ‘parking bay’ for surplus funds

• seek capital stability, interest income and high liquidity through a low-risk investment

1 month +

Low

South African - Interest Bearing - Money Market Mean

Provide capital security, a steady income yield and high liquidity

South African - Interest Bearing - Money Market

For full disclosure on all costs and fees, as well as performance fees FAQ, refer to the Minimum Disclosure Documents on our website: www.psg.co.za/asset-management

80% - 100%

Net equity exposure

• focus on a long-term investment horizon

South African - Equity - General

Fund category (ASISA classification)

No


R2 000 lump sum

Annually

80% - 100%

• focus on a long-term investment horizon

• aim to maximise potential returns within an acceptable risk investment

• seek an equityfocused portfolio that has outstanding growth potential

4 years +

High

MSCI Daily Total Return Net World USD Index (in ZAR)

Outperform the average of the world’s equity markets, as represented by the MSCI Daily Total Return Net World USD Index (in ZAR)

Global - Equity General

No


R2 000 lump sum

Annually

0% - 100%

• focus on a mediumto long-term investment horizon

• want to diversify their holdings across the world

• want a managed solution in offshore markets

4 years +

Moderate - High

US inflation +6% (in ZAR)

Achieve superior medium- to long-term capital growth through exposure to selected sectors of the global equity, bond and money markets

Global - Multi Asset Flexible

PSG Global Flexible Feeder Fund

PSG Global Equity Feeder Fund

PSG Balanced Fund

PSG Equity Fund

PSG Flexible Fund

Rand-denominated offshore

South African portfolios

Unit trust summary

Contact information PSG Asset Management unit trusts

Cape Town office

Local unit trusts 0800 600 168 [email protected]

Physical address First Floor, PSG House Alphen Park Constantia Main Road Constantia, Western Cape, 7806

Offshore unit trusts 0800 600 168 [email protected] General enquiries +27 (21) 799 8000 [email protected] Websites www.psg.co.za/asset-management www.psgkglobal.com

Postal address Private Bag X3 Constantia, 7848 Switchboard +27 (21) 799 8000 Guernsey office Address 11 New Street St Peter Port Guernsey, GY1 2PF Switchboard +44 1481 726034 Client services SA Toll Free 0800 600 168 Malta office Address Unit G02 Ground floor SmartCity Malta SCM 01 Ricasoli Kalkara SCM 1001 Telephone +356 (2180) 7586

20 |

The information and content of this publication is provided by PSG as general information about its products. The information does not constitute any advice and we recommend that you consult with a qualified financial adviser before making investment decisions. For further information on the funds and full disclosure of costs and fees refer to the Minimum Disclosure Documents on our website. Disclaimer: Collective Investment Schemes in Securities (CIS) are generally medium- to long-term investments. The value of participatory interests (units) or the investment may go down as well as up and past performance is not a guide to future performance. CIS are traded at ruling prices and can engage in borrowing and script lending. Fluctuations or movements in the exchange rates may cause the value of underlying international investments to go up or down. Where foreign securities are included in a portfolio, the portfolio is exposed to risks such as potential constraints on liquidity and the repatriation of funds, macroeconomic, political, foreign exchange, tax, settlement and potential limitations on the availability of market information. The portfolios may be capped at any time in order for them to be managed in accordance with their mandate. Excessive withdrawals from the fund may place the fund under liquidity pressure and, in certain circumstances a process of ring-fencing withdrawal instructions may be followed. The fund may borrow up to 10% of the market value to bridge insufficient liquidity. Unit trust prices are calculated on a net asset value (NAV) basis, which is the market value of all assets in the fund, including income accruals less permissable deductions divided by the number of units in issue. Fees and performance: Prices are published daily and available on the website www.psg.co.za and in the daily newspapers. A schedule of fees and charges and maximum commissions is available on request from PSG Collective Investments (RF) Limited. Commissions and incentives may be paid and, if so, are included in the overall costs. Forward pricing is used. Different classes of Participatory Interest can apply to these portfolios and are subject to different fees, charges and possibly dividend withholding tax and will thus have differing performances. Performance is calculated for the portfolio and individual investor performance may differ as a result thereof. All performance data for a lump sum, net of fees, include income and assumes reinvestment of income on a NAV-NAV basis. Income distributions are net of any applicable taxes. Annualised performance show longer term performance rescaled over a 12-month period. Source of performance: Figures quoted are from Morningstar Inc. Cut-off times: The cut-off time for processing investment transactions is 14h30 daily, with the exception of the PSG Money Market Fund, which is 11h00. The portfolio is valued at 15h00 daily. Additional information: Additional information is available free of charge on the website and may include publications, brochures, application forms and annual reports. Company details: PSG Collective Investments (RF) Limited is registered as a CIS Manager with the Financial Services Board, and a member of the Association of Savings and Investments South Africa (ASISA) through its holdings company PSG Konsult Limited. The management of the portfolios is delegated to PSG Asset Management (Pty) Ltd, an authorized Financial Services Provider under the Financial Advisory and Intermediary Services Act 2002, FSP no 29524. PSG Asset Management (Pty) Ltd and PSG Collective Investments (RF) Limited are subsidiaries of PSG Group Limited. Money Market: The PSG Money Market Fund maintains a constant price and targeted at a constant value. The quoted yield is calculated by annualising the average 7-day yield. A money market portfolio is not a bank deposit account. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures and in such circumstances a process of ring-fencing of withdrawal instructions and managed payouts over time may be followed. The total return to the investor is made up of interest received and any gain or loss made on any particular instrument. In most cases the return will merely have the effect of increasing or decreasing the daily yield but in the case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Fund of Funds: A Fund of Funds portfolio only invests in portfolios of other collective investment schemes, which levy their own charges, which could result in a higher fee structure for Fund of Funds portfolios. Feeder Funds: A Feeder Fund is a portfolio which, apart from assets in liquid form, invests in a single portfolio of a collective investment scheme, which levies its own charges and which could result in a higher fee structure for the feeder fund. Trustee: The Standard Bank of South Africa Limited, Main Tower, Standard Bank Centre, 2 Hertzog Boulevard, Cape Town, 8001. Tel: +27 (21) 401 2443. Email: [email protected]. Conflict of Interest Disclosure: The Fund may from time to time invest in a portfolio managed by a related party. PSG Collective Investments (RF) Limited or the Fund Manager may negotiate a discount in fees charged by the underlying portfolio. All discounts negotiated are re-invested in the Fund for the benefit of the investor. Neither PSG Collective Investments (RF) Limited nor PSG Asset Management (Pty) Ltd retains any portion of such discount for their own accounts. The Fund Manager may use the brokerage services of a related party, PSG Securities Ltd. PSG Collective Investments (RF) Limited does not provide any guarantee either with respect to the capital or the return of the portfolio and can be contacted on 0800 600 168 or on e-mail at [email protected]. © 2017 PSG Asset Management Holdings (Pty) Limited Date issued: 26 April 2017
