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[TOP STORY] Discretionary fund managers’ role in the investment landscape

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SIMON BROWN: I’m chatting now with Roland Grabe, head of discretionary fund management at Old Mutual Wealth. Roland, I appreciate the time today. Discretionary fund managers, DFMs – where do they fit into the investment landscape?

ROLAND GRABE: Simon, the main services DFMs provide are to financial advisors, and their objective is really to assist financial advisors in navigating the landscape of unit trust funds. So we’re investment experts that enable financial advisors to do a better job for their clients.

SIMON BROWN: Is that [in] fund selection, or is it more at a higher level, which perhaps would be sort of around asset allocation?

ROLAND GRABE: Simon, it can be one or both. In our case we get involved in asset allocation, so we select unit trusts from asset classes. Other DFMs might focus on [the] use of balanced funds. But the end goal of the proposition is to ensure that the financial advisor has a robust and well-constructed investment solution for each client’s need.

SIMON BROWN: Is it that granular in a sense, where it is sort of down to the individual? I’m sitting with my advisor and it can be granular down to this is Simon’s needs needs?

ROLAND GRABE: Simon, that’s an interesting one. In the global market, certainly some DFMs develop propositions that try to create a unique solution for each client. I would say in the South African market the focus is more on client segmentation – so to offer solutions, standard solutions at different levels of risk. A financial advisor might end up having between five and 10 standardised investment solutions and you’ll gauge the client’s need in terms of risk, but also in terms of offshore exposure, maybe currency exposure and, in the case of living annuities, perhaps look at the volatility that the client can endure while earning income.

SIMON BROWN: In the note sent out, talking particularly about the team that you work with – over a hundred billion ZAR – so it’s a large amount there. You say the majority of them are actually looking at that asset-allocation manager research, and then a couple of them on macroeconomic. I suppose that’s your really, really big picture in a sense.

ROLAND GRABE: Yes, Simon, and I think it’s an interesting challenge. We don’t think that manager selection is really the first part of the process, so we don’t think you start with whether you think Allan Gray or Coronation is a good manager. The importance of asset allocation has been well proven if you’re trying to fix the investment risk to something measurable.

So in order to make sure that clients know how much investment risk they take on, you do want control of the asset allocation, and so we’ve got a large team looking after a considerable amount of money, and we think it’s worthwhile spending a lot of our time first looking at asset allocation. In that, a decision like how much exposure to take offshore and how much to take in domestic currency we think is a much more important call than selecting between two or three or 10 different active managers.

SIMON BROWN: I take your point on that and I hear it often from guests and folks in the field – that getting your asset allocation right is more than half of the job. If you can get that right then the rest kind of falls into place – I don’t want to say easily, but a lot easier perhaps.

ROLAND GRABE: Yes. When I refer to international studies, that’s perhaps 90% of the decision. So really important. Of course, through selecting asset managers that take very big risks you can still make a difference on the upside, or you can burn your fingers quite badly.

But we think in terms of client objectives. And often when we do that we think ‘by how much does this client aim to beat inflation over a certain period?’ And that kind of formulates our goal for the investor, and around that we can build asset allocation.

The wonderful thing about this process is, if you do things that way you can actually get quite predictable results eventually, because you are investing through market cycles. In the long term markets actually tend to deliver fairly stable real returns. You know what to expect from equity markets, you know what to expect from the currency, and that gives clients a sense of plan, a sense of purpose, and also a way to remain invested in volatile markets with a long-term plan.

SIMON BROWN: I like that point. It doesn’t feel like it in 2022, but markets are, broadly speaking, going to be predictable.

You also talk around ‘enhanced indexation’, a new trend that you’re seeing with DFMs. What’s the thinking behind that?

ROLAND GRABE: Yes, Simon. In South Africa we are definitely behind the curve in terms of exploring more passive investment solutions. The simplest equity-market approach is to just buy each company according to its market cap. That will give you an index like the Alsi index, where your performance is just predicated on which stocks are on the index. So that we call ‘pure passives’.

And then there are two different types of enhancements that one can do to an index like that. You can try to control the risk by, for example, reducing the exposure to the large stocks, so you can buy something like the Capped Swix. What that index does is it limits the biggest stocks, like Naspers and Prosus, together. It limits [them] to 10%, so [they don’t] dominate a very concentrated portfolio. That is a risk-based approach.

But there also [is] so-called ‘smart beta indexation’, which tries to provide better risk-adjusted returns by bringing in different flavours, still with a programmed approach with a formula of how stocks are selected. That takes the human bias element out of it. These funds tend to sit at the cheap end of the spectrum, because there’s no research involved, or very little research involved to bring these indices together. And big companies, big asset managers then simply track a published index to give you a specific market return.

SIMON BROWN: That then fits, coming back to asset allocation, perfectly under the asset-allocation umbrella. You pick your assets and you use passive – it might be a Swix, it might be a smart beta that fits perfectly in with the assets.

ROLAND GRABE: Absolutely. So now you’re starting to put together an investment process where a big portion of your exposure you get for cheap. You get direct access and you get the returns from equity that you expect. But it also gives you more of a risk budget to select active managers on the other side, and allow them to do their job over the long term.

So by anchoring the portfolio around an index you now have more freedom to maybe select an asset manager that isn’t very consistent, that maybe only beats the market one out of three [times] – but when they do a good job, they do an excellent job.

So we think embracing passive actually gives you some risk capacity to stay invested longer with good quality active managers. There’s very attractive combination between the two.

SIMON BROWN: I hadn’t thought of that. I like it – that that passive, which gives you market, means you can step out on the edge a little bit in other places.

We’ll leave it there. Roland Grabe is head of discretionary fund management at Old Mutual Wealth. Roland, I appreciate the time.

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