Chief Investment Officer
In Greek mythology, Icarus is the son of the master craftsman Daedalus, the creator of the Labyrinth. Icarus and his father attempt to escape from Crete by means of wings that his father constructed from feathers and wax. Icarus’ father warns him first of complacency and then of hubris, asking that he fly neither too low nor too high, so that the sea’s dampness would not clog his wings, nor would the sun’s heat melt them. Icarus ignored his father’s instructions not to fly too close to the sun; when the wax in his wings melted he tumbled out of the sky and fell into the sea where he drowned, sparking the idiom “don’t fly too close to the sun”.
Complacency and hubris are emotions experienced not only by Icarus, but also by many investors. While this story from Greek mythology may be considered by some as being far removed from modern-day financial markets, we beg to differ. At Gryphon we believe it accurately describes not only the behaviours to be avoided, but also explains how investors need to navigate between the ‘dampness of the sea’, i.e. exposing themselves to insufficient risk to avoid their wealth being eroded by inflation, and the ‘sun’s heat’, i.e. overly-aggressive exposure to risk, which can have ruinous economic consequences.
To mitigate this conundrum, Gryphon offers two multi asset funds whose primary objective is to generate real (after inflation) returns for investors at lowest possible cost. We believe that producing investment returns is a function of two broad actions, (1) protection and (2) generation.
Gryphon has developed a series of proprietary indicators that identify prevailing market conditions and thus dictate which action should be undertaken i.e. is it time to protect capital or is it time to generate growth?
Equities is the asset class likely to generate inflation beating returns over the longer term and, when this asset classes offers value, these funds are fully exposed to equities. When this is no longer the case, and indications are that there is excessive risk in equities, protecting investors’ wealth becomes paramount and this will usually necessitate a move into cash.
Gryphon’s asset allocation decisions are bold. The funds are either fully invested in the asset class of choice or invested in cash. Towards the end of August 2018, these indicators signaled a lack of value and prescribed caution for the foreseeable future and, as a result, the funds moved from being 100% invested in equities into a 100% cash position. This decision served us well up to the end of December 2018, at which point the U.S. Federal Reserve ‘pivoted’ and suggested to the market that they were prepared to be ‘patient’ with regard to future interest rate moves.
This resulted in global equity prices rebounding strongly and markets reached close to their highs of recent months.
Does this mean we called it wrong?
Warren Buffet, recently stated “What the wise do in the beginning, fools do in the end.”While no offence is intended, we take the preservation of wealth very seriously. Our assessment remains that the promise of returns offered by alternative asset classes does not warrant the risk to investors; hence our position to remain fully invested in cash.
A fundamental indicator of the equity market, underlying earnings, has shown little if any change since August 2018, with the increase in market value being purely a function of re-rating i.e. an increase in the market’s multiple.
In our experience, too much money has been lost trying to eke out that last bit of return from an over-stretched market. This inspires our reference to Icarus, whom we would contend at this point is flying too close to the sun and, like Warren Buffet’s wise man, we are content to lead the pack in exiting equities.
We’ve also learned that the astute investor benefits from having cash available to be able to take full advantage of opportunities that always present themselves when markets do bottom.
When fund managers are caught exposed to a falling market, their investors suffer two types of losses which are often underrated, namely; (1) the cost of having to sell heavily discounted assets at the bottom of the cycle in order to reposition devastated portfolios and (2) the emotional turmoil of trying to defend/justify value in a falling market.
While the latter may not appear to be material, it is the failure to control these emotions when markets are negative and offering value that destroys long-term returns for investors.
In conclusion, a quotation from Sun Tzu, The Art of War:
“It is the unemotional, reserved, calm detached warrior who wins, not the hothead seeking vengeance and not the ambitious seeker of fortune.”
At the risk of being dramatic, the war against inflation and human nature is fought both at the top-of-the-cycle, when the temptation is to over-extend and over-stay, and at the bottom-of-the-cycle, when the temptation is to avoid because of fear and anxiety.
We maintain our decision as being appropriate, not only in terms of risk-adjusted returns of a portfolio, but also because it preserves the energy of our investors and allows them to make calm, calculated decisions when opportunities present themselves.
Below is a table detailing the performance of Gryphon’s multi asset funds against the return of the JSE over the same 60 month period. We would credit the excess return as the result of the ability to migrate between asset class in the longer term.
Given the state of volatility, uncertainty, complexity and ambiguity in this uncontrollable and unpredictable world, investment and broader, Gryphon’s tried and tested strategy offers a harbour in the crazy storm.