Ten years ago, in 2011, London came to a standstill as the city was overcome with scenes of rioting and looting, the Arab spring began, and there were protests against capitalism outside Wall Street.
There were also some significant natural disruptions around the world such as the earthquake affecting Christ Church in New Zealand and the Tsunami triggering the Fukushima nuclear energy disaster.
Meanwhile, in South Africa, we were in the third year of the Zuma administrations and starting to see some of the damaging effects of that filter through.
It was also the year the Nedgroup Investments Balanced Fund was launched. After 10 years of consistent performance, ranking second in the peer category group over the period, we asked Fund Manager, Iain Power to reflect on some of the key lessons he learnt while managing the fund over the past decade.
When investing in stocks with similar upside – always choose the better business
In the years following Zuma’s appointment as president, South Africa dislocated from the median countries around the word in terms of growth as local economic growth slowed significantly. Then, as the years passed and state capture became more entrenched, growth continued to decline which had a massive affect on a lot of South African companies and therefore stocks and investment outlooks.
“Investing against this backdrop has had obvious challenges. One of the big lessons we learnt over the last 10 years is that when you are faced with two securities with the same levels of upside and return – always defer to the better busines – higher return on business capital, which has a stronger moat that can see it through difficult times,” says Power.
So always choose the more solid business rather than the below average business irrespective of how cheap it is. “Generally, we think businesses that are cheap are cheap for a reason and it’s difficult to discern what is a value trap or a value opportunity.”
Cyclical stocks: make sure you are buying the business at the right price
Power stresses that once you have identified a strong business, it still needs to be at the right price to be considered a viable addition to the fund. “From a South African perspective, you need to understand where you are in the cycle and what a resource company is earning today versus what its sustainable earnings are through the cycle,” explains Power.
This means understanding what the normalised return for the business is, and then overlaying that with a sense of where the business is at today. “You need to assess where you are in the cycle and where the risks are in terms of the earnings and the ratings – especially when buying cyclical assets,” he says.
Be able to admit when you have made a mistake – and take appropriate action
The past ten years has been full of surprises, with events such as Brexit and Donald Trump being elected into the office of the US presidency. While Truffle have managed to avoid the negative effects of a lot of these events, Power says the one thing he has learnt is that when the facts change, you need to be able to change your mind.
“As a fund manager, I believe one of the big advantages you can give to your client is to not be dogmatic about your position. When your investments case looks like it’s wrong – you should reflect on that and have the intellectual honesty to admit that you made a mistake and cut the position. We would rather cut a position and re-deploy it where we can get a higher return if the experience turns out to be different to our base case expectation,” he says.
Surround yourself with a team that challenges every idea
Finally, Power says it’s crucial to have a team of investment professionals that will be able to interrogate every investment idea through rigorous debate.
“We have spent a lot of time developing our team and talent and we think we have a very strong bench. The reality is that we want to test the ideas in the furnaces of a robust debate. If those ideas can emerge from the debate unscathed, we believe it increases the probability of achieving the returns and also highlighting some of the downside risks.”