In our last letter to clients we resorted to a sports metaphor to describe the current market. Specifically we drew a comparison to a low scoring cricket pitch in the game of cricket. To be successful when batting on a low scoring pitch, the batsmen need to tailor their expectation of a possible score to the reality of what the pitch is offering in terms of runs. To go for a 300 run tally on a 150 run pitch may end up with everyone prematurely back in the pavilion with very little on the scoreboard. In our view the current investment market is this type of environment.
At the start of last year we felt that potential returns for the year would be of the order of 10%. This year we again feel that it is more of a 10% year than a 30% year. We also feel strongly that the market has a high probability of a couple of 10% drawdowns occurring over the next 12 months.
Rezco’s belief & practice is to Preserve Capital & Create Wealth for investors who entrust the care of their capital to us. This encapsulates our whole investment approach.
This does not mean we are timid and afraid to take risk, it just means that we want to take risk when we feel that we are being compensated for it by the market. There are times when the market pushes some investment ideas from very expensive to silly. We accordingly try to avoid these moves as the risk is just not worth it. During this part of the cycle Rezco portfolios will be conservatively structured so as to limit the potential downside.
This is best encapsulated by looking at Upside and Downside Capture ratios. The graph below clearly illustrates this strength in the Rezco investment approach. The fund has one of the best long-term capture ratios in its category. This has been achieved over the long term by avoiding the downside as well as capturing the upside.
During 2014 the fund achieved the memorable milestone of a ten year performance history. Interestingly enough the 10 years can be split into 5 high years and five average years as illustrated by the table below. Whilst our clients love us for the 30% return years, our goal is to play the long game really well. The average for the five high years is 28.8% per year, while the average of the five lower years is 9.7%.
The table above illustrates that returns do come in cycles. It is noted that Rezco has been able to generate positive returns for our clients over the long term, and avoid negative annual returns.
CURRENT MARKET POSITIONING
South African Shares
Our economic analysis leads us to the conclusion that the current bout of electricity shortages is seriously affecting real economic activity. This is on top of an already low sub 2% economic growth scenario. This will overwhelm the significant positive impact of lower fuel prices. The investment risk is therefore on the higher side. We therefore see it as necessary to build cash from the local equity part of the balanced portfolios.
We believe that international shares will continue to grind higher mostly because of a lack of alternatives. In the short term, Greece is almost certainly going to implode economically and leave the Euro. This should keep international markets on edge but ultimately Greece is too small to derail the rest of Europe. The USA economy is starting to heat up. Investors who are fixated on deflation could be caught unawares should the Federal Reserve have to increase rates faster than expected. We see this becoming an important factor around mid-year.
DIVERSIFICATION CAN BE A SOURCE OF STRENGTH.