A letter to our CIO
Looking at the asset allocation on the latest Prudential Fund Fact Sheet, it is clear that Gryphon has been “risk-off” since 2018 which was a major factor contributing to the remarkable results during the post Covid-19 global market crash and the downgrade of SA to sub-prime.
It is a concern, however, that the current risk-off approach has provided significantly lower returns than your peers over the past year. Looking at the current asset allocation, I can understand why. I see that there has been some exposure to precious metals for the last year, but the absence of SA Bonds and the heavy weighting in favour of SA Cash is, I fear, the reason for the reduction in performance.
I am finding it a bit difficult to explain to clients the benefit of staying invested in the Prudential Fund right now. Can you perhaps give me an indication if the strategy is likely to take on more risk soon, or do you have something that I can send to my clients that is likely to provide a better understanding.
Speaking to peers in the industry, some maintain that Gryphon just got lucky in 2019.
Thank you for your enquiry and the opportunity to engage. Answering your questions is difficult as we cannot predict the future and in fact avoid forecasting, but we appreciate being able to share where we are working from at this point: Equity markets, particularly international, are at elevated levels; historically, buying at these valuation levels, has not delivered good returns. Many fund managers see opportunities in South African equities. We would not dispute that; however, if there is a global drawdown, local equities will not escape unscathed.
So equities could fall (high probability, high impact) or they could rise (low probability, high impact) or they could continue at current levels for some time (high probability, low impact). In all three instances we believe that cash will provide the best “risk-adjusted” return.
We have been managing these funds for 93 months now; in that time we have been invested in equities for only 18 of those. That is not what we anticipated when we originally designed the product. It is, we believe, reflective of the valuations that equities have traded at over this period.
Notwithstanding our avoidance of equities, we have delivered an annualised return of 9.7% since the funds’ inception in April 2014, as opposed to equities’ return of 9.1%, 8.4% from bonds and 6.4% from cash. We have done this at far lower levels of volatility than either equities or bonds and have experienced no negative 12-month rolling periods.
We can’t predict when we will get back into equities – we rely on our indicators which are based on macro fundamentals to signal that. It can, however, happen very quickly and thus we remain vigilant. We don’t expect future returns from equities to be as stellar as they have been over the past 2 years because of central bankers raising interest rates and engaging in quantitative “tightening” rather than “easing”.
These funds protect investors’ capital and, when the opportunity arises, have the flexibility to immediately move into whichever asset class offers the most risk-adjusted value. Those of us who have lived through a market drawdown know that having to sell an asset under pressure to buy another can destroy a lot of value. Our holding cash at times of elevated risk levels and volatility ensures that we don’t find ourselves in that circumstance.
While we appreciate the frustration in not offering greater clarity on what we’ll be doing when, this is very much dependent on the behaviour of global markets and the business cycle.
What compounds the level of discomfit perhaps, is our position relative to the crowd. It’s human nature to be more comfortable standing with the crowd. Our rules-based philosophy removes emotion, specifically fear and greed, from our practice and sometimes the result is uncorrelated behaviour.
“Neither a man nor a crowd nor a nation can be trusted to act humanely or to think sanely under the influence of a great fear.”
A further point for consideration: some investors refer to our position of being “in cash” as lucky and believe that they could also just sit in a money market fund. For the period since August 2018, when we sold out of equities, the fund has returned 10.9% matching equities return of 10.9% and comfortably beating cash’s 5.7%. So, we have outperformed cash considerably and have matched equities though at much lower levels of volatility. While the past 12 months have been muted, this followed a period where we delivered a 20% plus return for investors as result of our exposure to bonds. We believe we will continue to achieve our benchmark (CPI +5%) on a rolling basis into the future.
We are quite candid regarding our lack of confidence in predicting the future. What we are confident of is that the philosophy and process that has delivered above benchmark returns over the last eight years is likely to continue to do so as long as we honour this process and remain unflinchingly committed to it in the face extreme challenge. Because markets go in cycles, there are times to take on higher levels of risk, but then there are also times to rather de-risk. Getting caught in a big market drawdown is devastating on the capital value of investors, especially for those that may need their investment at that specific point in time, and it may take years for that loss to be recovered. The strategy on which these funds are based have proven to be accurate and reliable in the past and we continually prod and review to ensure that they remain sound and relevant. Currently they indicate a need to be cautious, to avoid risk. Times like these are usually accompanied by great uncertainty and very little visibility into the future, market volatility high.
Charlie Munger said, ‘take a simple idea, and take it seriously.’ We take this idea very seriously and have done for nearly thirty years. Much of our own personal wealth is invested in these funds and so we do not stand at a safe distance and holler support from afar.
In conclusion, some wisdom from Winston Churchill:
“The farther backward you can look, the farther forward you can see.”
“If you’re going through hell, keep going.”