Investment management is a competitive industry where fund managers seek to optimise the returns of their portfolios and so grow their funds and businesses.
Transparency, as a result of regulation, is increasing the competitiveness of the industry as there is simply no where to hide, even for discretionary segregated mandates. For investment management businesses to remain competitive and profitable, they need to know what their competitive edge is compared to their peers.
Lessons from an aspiring athlete
I competed in athletics throughout my school career and, like many young aspiring athletes, I dreamed of one day making it to the top of the sport. By the time I reached university and competed at a senior level I posted a relatively decent time of 48 seconds in my favourite event, the 400m. While, I was nearly 5 seconds of the world best of just over 43 seconds (held by Michael Johnson at that time) the optimism of youth spurred me on to continue running this event even though I should probably have focused my efforts on the longer 800m, 1500m and mile events. The reason for this can be seen in the table below where I compare my 100m, 300m and 400m to Michael Johnson’s times.
- Success requires a combination of ability (at the required level), hard work and avoiding injuries (looking after your body).
- The sooner you recognise that you are not competitive, the faster you are able to pick a different competitive event that you are more suited to. In my case it should have been moving up to the middle distances.
- Picking a new or different competitive event does not guarantee success and is rarely easy. For example, running middle distance races requires a very different mindset to running the sprint events.
- Guidance and feedback are essential – the role of your coach is not just to provide a training program. Another important role is to structure training with injury prevention in mind as this ensures continuity.
Investment management has become extremely competitive over the past 40 years
Over the past few decades competition in the investment industry has increased substantially as investment skill levels have risen and “weaker players” have gone out of business. This has resulted in the smaller return differences between investment managers - which in turn, allowed for passive strategies to provide top decile performance due to lower investment management fees. The increased adoption of passive investment strategies in recent times has accelerated this process, leaving only the strongest investment firms to slog it out for top honours.
Furthermore, as regulation has driven transparency around costs and performance, it is becoming very difficult for average managers to justify the high fees traditionally charged for managing active unit trust or discretionary segregated portfolios. There is therefore “less fat” in the industry making it even more difficult for average managers to stay in business.
Regulation has also driven the standardisation of “investment games”, for example the Asisa categories that define the mandate limits of all registered unit trusts. This standardisation makes competition even tougher and has led to the largest funds in each Asisa category making up most of the assets. Over time this will lead to similar adoption levels of passive investment strategies as seen internationally as their lower fees allow them to be competitive compared to the major incumbents.
Core Accelerated - the fund with a competitive edge
The standardisation of investment games has its own downside, namely that incumbents play it safe and therefore design their mandates so that they do not differ much to those of their main competitors. A good example is the Asisa South African multi-asset high equity category, which houses most of the balanced funds used for retirement and discretionary savings.
In a previous article we showed that the large balanced funds have held an average combined allocation to equity and listed property of 66% over the past 5 years. This is significantly lower than the maximum limits allowed by Regulation 28 of the Pension funds: 75% for equity and 25% for listed property. As retirement savings are invested over decades it makes sense to maximize the exposure to growth assets (equity and listed property) as the investor has a long enough time horizon to ride out the market drops that occur from time to time.
The Nedgroup Investments Core Accelerated Fund was designed to maximize the growth exposure within a Regulation 28 compliant balanced mandate. It has a strategic equity allocation of 75% and listed property allocation 15%. We limited the listed property allocation to 15% due to the listed property sector having so few shares (~30) and the market capitalisation of the five largest companies making up more than 50% of the listed property sector. The allocation to growth assets in the fund is almost as high as general equity funds as shown in the chart below:
- Less weight = lower fees – The Total Investment Charges of the fund is over 1% lower than the average balanced and equity funds
- More Power = higher equity and property allocation – The allocation to growth assets in the fund is almost as high as the large general equity funds and therefore offers greater growth potential compared to balanced funds.
- Less prone to injury = broader diversification – The fund offers broader diversification across and within asset classes. The fund holds ten different asset classes with nearly 11 000 individual holdings.