Cape Town - Admitting that his company will make mistakes, Duncan Artus of Allan Gray says in its quarterly newsletter on Tuesday that the recent investment environment has been particularly conducive to mistakes.
"While we hate to lose even one rand of our clients' savings to a permanent (as opposed to a temporary paper) loss of value in an asset," he said, "we are aware that we will make mistakes - in truth, more often than our clients expect from us. That is the nature of investing with imperfect information and imperfect foresight."
Nevertheless, he reckons that by learning from the mistakes of the past, investment managers can avoid getting things wrong, and declares that at present Allan Gray have increased steadily the weighting to equities in asset allocation funds.
This, he said, "is driven by our work on individual companies highlighting that an ever-increasing number of shares which we do not own currently are offering potential four-year total returns above that currently offered by rand cash. Clearly, we hope our shares will do better."
Artus says that the make-up of the equities in their funds has not changed too much over the last year, which has surprised some. "Sometimes doing nothing is the hardest thing to do when managing money," he said.
"However, we did make two big decisions over the past year: closing the hedge in the asset allocation funds and maintaining our large individual equity positions."
He points out that earnings for many domestically focused businesses remain high by historical standards, despite the bad economic news.
But he adds: "We believe that, in many cases, the bad news has yet to be reflected adequately in their ratings. Investors (including ourselves) often take a long time to factor in fully the possible extent of downward revisions in future earnings forecasts.
"Over the recent past we have been spending most of our time evaluating potential downside to earnings. The really tough part, of course, is that profits are inherently interlinked across industries, and the downward pressure can spread quickly to businesses that have held up so far.
"Our apparent error in some cases in this bear market has been to underestimate the extent to which what appeared to be low earnings (in admittedly lower-than-average quality businesses) have fallen further, such as in the paper and transportation stocks."
Artus notes that the government may have difficulty in funding its huge infrastructure building plans, and in that case it is likely that there will be a much weaker currency or higher long-term interest rates, which will make local asset prices more attractive to foreign capital. "This is not certain, but quite probable," he said.
He concludes: "Of course, the potential return depends on our forecast of future earnings which - we see as the variable we are most likely to get wrong. The potential for big downside surprises remains far higher than normal, in our view.
"The consequences of the de-leveraging of corporate and consumer balance sheets as earnings come off a high base is difficult to model with high conviction. We have attempted to take the prospect of significant downside surprises - Anglo is missing a final dividend for the first time in 70 years - into account when selecting the blend of equities for inclusion in our funds.
"We believe that our chosen equities will outperform rand cash on a four-year view, but we continue to caution that the margin of out-performance will be smaller and more volatile than during the 2003 - 2007 bull market. In addition, the shares that make up a significant portion of the current portfolio are different from those the funds owned in 2002/03. This time has been different."
- I-Net Bridge