The past month has seen some really significant falls in world equity markets. The All Equity Index of South African Unit Trusts is down in the order of 27% for the year thus far. Fortunately the Rezco fund is still showing a positive return for the year. The 3 year period to October 2008 presents an interesting opportunity for investors to measure their fund manager’s skill. We have now had a roaring bull market followed by a plunging bear market. This enables investors to assess performance across the range of investment conditions. We are grateful to be able to report to the Rezco members that their fund is ranked number 1 out of all 475 South African Unit Trusts for this period.
The difference that is found in Rezco
Modern finance from time to time tends to collapse under the weight of its own hubris. How do so many incredibly smart people, on occasion, manage to get it so uniformly and horribly wrong? At the heart of this problem is the difficulty in finding the correct weighting between acceptable risk and expected return. In the competitive world of asset management, return is everything and risk eventually gets down-weighted. Put another way, Money Managers are paid for the returns they attain but are not charged the cost of the risk they assume. This does not mean they are by nature a reckless breed but that there is a tendency toward assuming risk unknowingly. The major risk control measure becomes the conventional wisdom of the moment, also known as the safety of the herd. This works for a time as it is has a self-fulfilling nature about it. That is, until the herd heads off the cliff.
One of the truly amazing things about the declines in both the local and international markets is the symmetry of positions held by many of the players. At Rezco we attempt to detach ourselves from the herd mentality.
We achieve this by the following:
- Collectively our managing partners have close to 90 years asset management experience between them. This is invaluable when investing across the range of market conditions. They have held senior positions at large asset management companies but now deeply value their independence. We deliberately avoid being based in one of the large South African money management centers namely Sandton or Cape Town. With the advent of broadband internet, information has become independent of location. What is important is being located where one can make the best decisions uncluttered by the emotion of the moment.
- Our relatively small size enables us to react far quicker to changing market conditions. The fund is however structured to be replicable in a larger form.
- Our robust research and equity selection process works across the range of market conditions.
Current Investment Outlook
It has become clear that the Developed World economies are headed into recessionary conditions. The initial crisis which revolved around the world banking system failing has in our opinion now passed. What we are left with are the secondary effects of a major credit contraction. Preventing banks failing may prove to be far easier than getting them to lend with any degree of passion. This may be self-reinforcing in that companies are forced to reduce activity due to restricted credit causing a recession which justifies banks becoming more risk averse and cutting lending further.
China will not grow GDP at over 10% per annum ad infinitum. This means that the commodities bull markets is now effectively over. China will continue to grow rapidly but at nowhere near the levels needed to keep most commodities in shortage conditions.
Throwing money at the problem
The world central banks have, we believe rightly so, shown an amazing willingness to throw serious money at the liquidity problems facing the world economy. Until recently only Zimbabwean taxi drivers mentioned a trillion Dollars in daily conversation, now the World Bailout cost is already well north of this amount. There is something to be said about the perception that the central bankers are “adding dross to the silver”. Although cash is undoubtedly the current king of the investment pile, we believe that this process will eventually penalize holders of cash assets.
Many past market corrections were driven more by emotion that by real economic problems. This led to a mindset that markets always go up and any weakness should be used to accumulate shares. We do not believe it will be as simple this time around and therefore emphasize the need for caution. We believe that current prices have probably recognized a large proportion of the bad news. The astute investor should in our opinion use further weakness to cautiously accumulate great assets. We do not believe that this will be a “tide that lifts all ships” but that asset selection will be paramount to achieving good investments returns.