London Revisited

Given how much value we got from our trip last year to London, we were really excited to head off again in late May to get our annual offshore fix. Our 2016 trip was incredibly insightful for our fledgling business, as it very quickly contextualized South Africa’s relative size in the investment universe (you will recall Blackrock and Legg Mason’s AUM at that stage were $ 5.2trillion and the JSE market cap was at     $ 186 bn). In addition, the different styles of asset management were quite revealing in that, as South Africans we are programmed to accept larger “bets”, whilst offshore they are very comfortable with small incremental returns across a very broad set of holdings. I guess the investment universe is so much bigger.

Fundhouse, our partners on our Investment Committee, were once again excellent in crafting an agenda that I am comfortable not many SA advisors would be able to put together. Their growing reputation amongst UK based Fund managers, reflected in their recent award as the “Best Ratings/Research Service for Advisors” in the UK, gave us access to a broad cross section of managers – some we use and others were exposed to for the first time. The trip lived up to all expectations and then some.

But before recapping our thoughts on the Investment world we encountered there were a few things that really stood out for us on our trip this time.

·         Getting around London via taxi or bus is time consuming. Central London is bumper to bumper, even though there has been a concerted effort to expand the public transport network with new Underground stations and overland lines. The use of cycle transport seems to be growing apace, and we often used the Boris Bike system to get around.

·         Property Development, be it new build or renovation seems to be continuing. We mentioned the number of cranes in evidence last year, which seems to have dropped off a little. A lot of that stock has now been developed, which has delivered large blocks of rental stock, and makes buying residential property a slightly more challenging capital allocation call. We were fortunate to meet up with a London based ex-South African who showed us around for the morning, looking at many investment opportunities and previous projects he had completed. It was clear to us that there are opportunities for capital upside or yield, but they need to “scratched” out, with hard work and a great network. The shadow of Brexit also sits over the London residential market, challenging the demand side of the equation.

       We often marveled that London had become purely a shopping destination. Was London not once the place to travel to experience Buckingham Palace, the Tower of London a host of excellent museums? I am sure that these are still popular but rampant consumerism seems to have overhauled the cultural experience. Oxford Street, Regent Street, The Kings Road ….. in fact, any road …. was awash with people looking to shop at a range of global brands represented in numerous outlets. And access to food was comfortably addressed by a swathe of restaurants and fast food outlets. I guess the sheer volume of people living and visiting London need to get fed!

·         The growing impact of technology – good and bad! The BA IT glitch (The Bad) ensnared us on our first attempt to return. Whilst the woefully inadequate number of BA staff informed us at Heathrow of our current predicament ….. “we do not know what is going on and because ALL systems are down, we cannot help you either!” …….. we got busy on our iPhones. In just short of 5 minutes we had:

§  Contacted our families to update them

§  Booked a hotel on lastminute.com (given the BA mess, hotels were running at 96% occupancy)

§  Booked return flights within 24 hours using our Emirates app

§  Booked an Uber back into London

§  Re-arranged our meetings back in Cape Town

Given that flight and hotel bookings are driven by computer algorithms, the systems were very quick to recognize the spike in demand, and adjusted by shifting prices up automatically. Great if you are the business selling, and not ideal if you are the schmuck at Heathrow.

·         We arrived on the day of the Manchester attack, and left prior to the latest act of terrorism in Borough Market. The response by Government was to significantly build their police and army presence in the capital. It was not uncommon to see large groups of police or army personnel, fully armed, in public spaces. This did not seem to sway the masses as they carried on with life under the famous UK slogan  …… Keep Calm and Carry On!

Some High-level Investment Observations

1.      The Passive vs Active management debate is a major issue offshore. In the US, significant flows are being invested via trackers and ETF’s versus active managers (this is reportedly greater than 50% of flows). All this to save management costs and due to managers not fulfilling on the mandates (i.e. underperforming). Some active managers in the UK see this as an opportunity as they can take advantage of some of the ETF structural issues such as capital flowing into ‘popular styles’ rather than fundamentally good investments. Risks in ETF’s were highlighted, i.e. using an emerging market ETF which is massively overweight sovereign SOE’s. The question being asked – “Would you want to invest in Russian utilities?” Some of these risks were however just managers talking to their book.

Our view on passives is that they can play a role in a portfolio, depending on where in the market cycle you understand yourself to be. If markets are perceived as cheap, passives are a good way to get the beta of the market cheaply. However, if you have a concern about valuations, stock picking should become more important and one would want to be underweight ETF’s as the gearing to the downside is 100% correlated.

2.      Both Emerging Market and Value managers are experiencing a meaningful resurgence in their sectors. Both have had a torrid last 3 years, with significant outflows and negative performance during this time. Money is finding its way back as investors seek out sectors showing signs of profit growth. Valuations are cheaper in EM than DM and the margins are improving with positive earnings revisions numbers coming through.

This aligns with our views, and we have taken overweight positions in both these areas within our solutions.

3.      Many fund managers used to extol the virtues of the “Top Down” or Macro approach. This has been replaced by the bottom up view – looking for unique opportunities. Given that we have come through – and are still experiencing a period - where the “normal” risk /return profiles of each asset class are practically inverted. By this we mean that cash used to be low risk, low return and equities high risk, high return and bonds somewhere in between. This is now a little on its head in that cash is giving you no return, some bonds negative returns and equities are the “safe haven” asset class! So, I guess asset managers may have responded in the only way they could ….. seeking out opportunities bottom up! Once they have built the portfolio in this manner they then overlay other risk parameters (i.e. sector, country exposures etc.)

4.      All managers are watching and waiting for QE (Quantitative Easing) post the global financial crisis, to normalize. Green shoots of economic turnaround (i.e. growth of some sort) will encourage central banks to remove liquidity from the system. This will hopefully align with an environment that see’s interest rates increasing and assets classes reverting to their “normal” valuation metrics. The Managers were consistent in their thinking that QE had to go before we could contemplate anything vaguely described as normal.

5.      All the managers we saw had their views on what is successful and what “secret sauce” they had that was different from their competitors. In addition, the proliferation of their product offering seemed to be based not on what was needed to meet best advice but rather by what could sell. The choice is vast.

So, working with a team like Fundhouse has enabled us to see the wood for the tree’s and identify those managers whose promise was not lived out by actual management and performance, and whose solutions were more for shareholder return than investor return!!

These trips add so much colour to our view on the world and are very fortunate to be able to participate in an outing like this. The valuable insights and experience gained will no doubt add value to our business and processes and ultimately to our clients.

And again, no trip would be complete without making the most of the sights and sounds of London.

All the best,

Paul and Andrew