Fund Focus – PPS Moderate Fund of Funds
Published Date: 09/13/2023
Source: By Luigi Marinus, Portfolio Manager
The PPS Moderate Fund of Fund is the ideal investment for someone who requires a long-term investment with reduced volatility compared to a standard balanced fund. The fund of fund is in the ASISA SA Multi Asset Medium Equity category and therefore has a maximum equity allowance of 60% and a maximum total offshore allowance of 45%. The fund of fund aims to deliver a return of CPI+4% over time while remaining competitive against its peers in the ASISA category. Although volatility is reduced by the lower equity exposure, the combination of domestic and global equities will be at a level that can deliver above-inflation returns over time.
As a multi-manager PPS Investments uses two diversification methods to deliver a more consistent return profile, namely asset allocation and underlying manager selection. Asset allocation is determining the appropriate combination of local and global equities, bonds, property, and cash. Underlying manager selection is researching which managers are best for different asset classes and/or market conditions and how to appropriately blend these managers.
Asset Allocation
Historically equities is the asset class that has delivered the highest return, however, this has been achieved at the highest volatility too. The risk-return characteristics of each asset class is therefore assessed to produce the appropriate combination for the level of return the fund of fund is aiming to achieve. By considering the performance profiles of each asset class, the investment risk can be appropriately applied. A long-term combination has been modelled for the PPS Moderate Fund of Fund which is the base case asset allocation called the strategic asset allocation. This base case combination has been shown to achieve the inflation target over the long term with the appropriate level of risk. Periodically, and at least quarterly, the asset classes are assessed independently and relative to each other. This may result in a marginal tactical adjustment to the asset allocation combination based on valuations, macroeconomic data and momentum, resulting in overweighting or underweighting certain asset classes compared to the long-term strategic asset allocation levels. This helps to reduce overall portfolio risk in risk-off periods and can increase risk in risk-on periods. These shorter-term tactical moves, called tactical asset allocation are meant as a tilt to the asset allocation and will not deviate too far from the base case levels as the long-term goals still need to be maintained.
Manager Selection
Our investments team applies a consistent process in assessing managers. The three key pillars of assessment are Organisation and Strategy, People and Support and Investment Approach. Within each pillar there are various aspects being researched resulting in a rating for each pillar. Only managers and
funds that reach a certain minimum rating for each pillar will be considered for the buy-list and thereby possible inclusion in the PPS Moderate Fund of Fund. By applying a repeatable manager selection process there is a consistency in the assessment of managers which makes comparisons possible. In the last year, the investment team has had 239 engagements in total with 81 different local and global asset managers. In that time we assessed 169 different strategies. Each engagement is discussed among the investment team members in weekly manager research meetings, ensuring that different perspectives are considered and only the appropriate managers make it to the buy-list.
Bringing it together
For the PPS Moderate Fund of Fund portfolio construction combines the asset allocation and manager selection decisions. The aim of the asset allocation is to have the appropriate combination of asset classes to deliver the long-term inflation target without unnecessary risk, while the aim of manager selection is to combine managers from the approved buy-list that deliver strong returns in different market conditions. The advantage of manager blending is that the need for economic forecasting is minimized as the combination of different underlying managers with different investment approaches will deliver competitive returns regardless of how the macroeconomic conditions play out. Over time the fund of fund has therefore experienced very few changes in underlying managers and has remained competitive in the category.
Risk return characteristics
There are various ways to consider performance but when assessing risk and return, the information ratio is an important metric. The information ratio measures the active return compared to the active risk relative to a benchmark – or how much return is produced per unit of risk. The higher the return per unit of risk, the better the risk-adjusted return.
The chart below shows the information ratio of the PPS Moderate Fund of Fund (blue circle), compared to CPI+4% (green square) and the funds in the ASISA category (grey circles) over the roughly ten-and-a-half-year history of the A2 class. The PPS Moderate Fund of Fund has delivered an information ratio close to 0.9, with CPI+4% at roughly 0.3 and the best of the remaining funds in the category closer to 0.6. This highlights the ability of the fund of fund to deliver returns at a lower level of risk.
Source: Morningstar, 30 June 2023
The chart below shows the consistency of returns compared to the ASISA category over rolling five-year periods. Since the inception of the A2 class, but for a brief period in 2022, the fund of fund has delivered first-quartile performance over its investment horizon, showing that even with few manager changes and in different market conditions over the period, the consistency of competitive performance has been maintained.
Source: Morningstar, 30 June 2023
Even when assessing the fund of fund on only performance the table below shows that over all periods the category average has been outperformed and over the longer term first quartile performance has been achieved.
Source: Morningstar, 30 June 2023
The popular investment adage of greater returns requiring greater risks may hold some truth, but some risk mitigation is possible with more diversification options. The PPS Moderate Fund of Fund holds true to its name by accepting a moderate level of risk while still achieving above average returns consistently over a long period of time. Investors looking to moderate their risk somewhat may find that this fund of fund is appropriate for their long-term investment requirements.
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