People often stress the importance of asset allocation. For example, we have heard it said that 90% of returns are directly due to asset allocation. We tested this theory using real-world data. Imagine an investor who has either 60% in shares and 40% in cash, or 40% in shares and 60% in cash. He can switch once a year, and he does so perfectly, every year: by magic he knows in advance which asset class will do best. In years like 1930 or 2008, when markets are down, he holds 60% cash, and in years like 2009 he has 60% in shares. In my view, one couldn’t hope to do better than this in real life: a 20% shift in equity exposure, done perfectly every year.
So, how far would our imaginary investor outperform a passive portfolio with a fixed equity exposure of 60%? In both the US and South Africa, over most time periods, by about 1% per year. Not very much, given that he has perfect foresight. Someone who can produce 2% equity alpha per year on a portfolio that is always 60% in shares would add more value.
We have done an analysis on our Balanced Fund, and we estimate that asset allocation has added somewhere between 0.60% and 0.75% alpha since inception. We can’t be more precise than this, because the Balanced Fund uses a peer benchmark, which has varying weights to each asset class. These don’t sound like big numbers, but they compare well with the 1% that our imaginary asset allocator has added over time. The vast majority of the Balanced Fund’s outperformance has come from stock selection.
In conclusion: asset allocation can add value, but typically not as much as stock selection. Fortunately, investors in the Allan Gray Balanced Fund have benefited from both.
The Fund’s performance over the past quarter was helped by overweight positions in KAP Industrial Holdings and British American Tobacco, and by underweight positions in BHP Billiton and Steinhoff. It was hindered by being overweight Sasol and Remgro, and by being underweight Richemont and Naspers. All this is relative to the FTSE/JSE All Share Index. We increased our exposure to Mr Price and MMI, and we reduced our exposure to Standard Bank and Nedbank. Strong returns from our offshore investment partner Orbis relative to international markets were mostly offset by a stronger rand, which means the portion of the Fund invested offshore was a drag for the quarter.
The Fund is a collection of undervalued assets that we believe will yield good real returns to investors over time. It is conservatively positioned and ready to take advantage of any opportunities that may arise.