Offshore investing - Allan Gray
Offshore investing

Allan Gray-Orbis Global Fund of Funds update: Balancing risk and return

A large portion of the Allan Gray Orbis Global Fund of Funds (the Fund) is invested in the Orbis Global Balanced Fund. But what is a “balanced fund”? The moniker has become so common that it’s all but lost its meaning. Are we balancing stocks and bonds? Income and growth? Momentum and value?

To us at Orbis, it’s simple: we are trying to balance risk and return. Operating with a moderate risk profile, our goal is to provide the best possible return we can, in the most efficient way possible, in any market environment.

Before we go any further, it’s worth defining what we mean by “risk”

When normal people ask whether an investment is “risky”, they mean, “am I going to lose money?!” It’s pretty simple, and no one likes losing money. But when financial professionals talk about risk, they are often speaking about something very different backward-looking statistics like beta, volatility, or tracking error. Those statistics have their uses, but they are not our primary focus. When we think about risk, we are thinking about the chance that the fund loses money. And in our view, the best way to lose money is to pay more for something than it’s actually worth.

Since we believe that yesterday’s “safe” assets can become today’s “risky” ones, we built the fund to be flexible. We are largely agnostic to labels like “income” and “growth” or even “bond” and “equity”. Function is more important than form, and each security we buy must help the portfolio deliver better bang for its risk buck.

So how are we striking that balance in the current environment?

Although stock markets around the world arguably look expensive, we have found a number of individual stocks that appear to trade at a substantial discount to their fair value. We have found some attractive bonds too, but fewer of them. Today, we believe selected stocks offer the best potential for good long-term returns, so the portfolio has a high proportion of its assets in them. Leaving that much exposure to stock markets would be too risky, however, so we must find a way to balance this out.

We know the classic answer: hold a bunch of government bonds. Historically that has worked extraordinarily well. On any backward-looking measure, bonds look low-risk and a 60/40 blend of stocks and bonds looks “balanced”. But backward-looking measures can’t tell you if an investment will lose money in the future.

While government bond yields have started to increase, we believe most continue to carry serious price risk if global interest rates keep rising. In light of this, we don’t think we can rely on a broad basket of bonds to balance the risk of our favoured equities. That presents a challenge. If we like some equities but we don’t like most bonds, how do we maintain the portfolio’s balance?

We have sought to lower the portfolio’s risk in four ways: searching for attractive corporate bonds, hedging stock market exposure, avoiding expensive stocks and buying short-term US Treasury securities. Taken together, these decisions result in a portfolio which looks very different from its 60/40 benchmark – hopefully it offers both lower risk and higher potential returns. And in ten years’ time, when market prices look very different than they do today, we would expect the portfolio to look very different as well. However we get there, we will always manage this Fund to the same goal: a balance of risk and return.

Over the quarter, the Fund sold several cyclical shares that had performed well, rotating some of this capital into one-year US Treasury Notes. With a 2.1% yield, minimal interest rate risk, no stock market risk, and excellent liquidity, we believe short-term Treasuries enhance the portfolio’s risk-adjusted return potential.

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