1. Art and Diseño

WHY WE ARE VOTING “NO” IN THE ALLAN GRAY EQUITY FUND BALLOT
Dear Investors,
If you are a small retail investor and this fund makes up the majority of your investment portfolio,
then you could be well served to diversify further offshore in a tax friendly manner and should vote
YES to the proposed changes if your embedded capital gains is relatively large and wealth
management compass is unaffected after reading our reasoning below.
As a holder of units in the Allan Gray Equity Fund you would have received a notice (“Proposed
changes to the Allan Gray Equity Fund”) on the 3rd of December 2014. Cordatus is voting “NO” to
the proposed changes on behalf of investors where we have discretion and our recommendation to
investors, where we act in an advisory capacity, is similar. We debated the issues below ad
nauseam internally at Cordatus as we believe this ballot represents an important point in the retail
industry evolutionary process.
Our rationale for the “NO” vote is as follows;
Proposed change #1: Allow the fund to invest up to 25% in global equities and a further 5% in
African equities
•
Let’s start with the obvious. When we first invested in this fund we knew that we were
buying SA equity exposure (that’s what it said on the tin!) and were content with that
limitation. Over time our returns from this fund has been in line with expectations and we
have been very happy. Our rejection of the ballot is not about offshore equity per se, it is
about changing the rules halfway through the game!
•
Cordatus makes use of a number of offshore options when constructing client portfolios.
The amount to be invested/exposed to offshore markets is a function of inter alia liability
matching (e.g. ZAR income needs), inflation protection levels (i.e. real return requirement),
volatility profile and asset valuation. Thus, we require a large degree of control over the
offshore exposure of our investors, which is derived and then aligned with the risk profile
and return requirement (risk capacity, risk tolerance and risk requirement) of each investor.
Voting NO will ensure the offshore allocation (across multiple holdings and asset classes)
of investors is not compromised by geographic decisions taken at Allan Gray within the AG
Equity Fund. I would hazard a guess that once they have moved the 30% allocation into
offshore controlled funds the chances of them actively managing this position (i.e. ever
repatriating the funds) are negligible, regardless of currency view.
•
With the fund using only Orbis Funds for the global equity component (30% max), where an
investor has an existing position in Allan Gray Global Equity FF and/or Orbis Global Equity
Fund, the position size is increased in terms of offshore manager exposure. We advocate
diversification as a core philosophy at all levels (including global equity manager level) and
this risk mitigation tool/practice is thus compromised to a larger or lesser extent as a result.
•
Ignoring the importance of market/instrument valuations being conducive or not, a growing
trend within investor portfolios is to make greater use of low cost index options when
investing globally. We support this move and given the wide variety of cost-effective options
available to Cordatus as custodians of your wealth, we would prefer to allocate this
component of your offshore exposure accordingly when intra-class valuation ranges allow.
Proposed change #2: Change in fund benchmark
While we agree that should an SA equity manager be allowed to invest offshore within their fund
that the JSE All Share Index is no longer appropriate, the proposal by AG to use the sector
average (value-weighted average return, excl AG) as a benchmark is, in our view, not appropriate
either. By way of illustration;
In the table below we list the 10 largest funds (excluding AGEF) in the SA – Equity – General
sector (all data from Morningstar as at 31/12/2014). A few points become very important given that
the sector average benchmark is asset weighted.
•
•
•
The AGEF is R40 billion in size.
The top 10 funds (excl AG) currently make up 54% of the sector.
90% of those top 10 funds do not invest offshore directly (after a quick glance at latest fact
sheets).
Thus, we are not subscribing to the AG argument on four important fronts;
•
•
•
•
The sector average (whether weighted or not) has very little in its’ favour as a point of
reference in measuring the returns of AGEF against our reference benchmark of the JSE
All Share Index (incl dividends). What’s so difficult with using a composite benchmark of
75% FTSE/JSE All Share + 25% MSCI World Index. This would allow them plenty of
opportunity to add alpha and not just on the currency.
The largest 8 managers do not have direct offshore exposure within their fund as an
addition so the argument as to this point is rendered obsolete. Of the largest SA shares, the
vast majority are offshore directed (e.g. SAB, BTI, etc) and the expansion plans of most SA
companies is decidedly externally.
The age-old argument that the size of your fund does not matter seems to have been
forgotten in this proposal or at least been conveniently glossed over.
We expect AG to do their best within the funds’ investment universe of SA equity. We will
take the punches as markets falter and will share in the good times. Given that valuations
are high in the larger cap shares where AG is “forced” to play we get the distinct feeling that
this ballot point is more about managing the AG business risk toolkit than applying tried and
tested valuation analysis over full cycles.
AGEF: WHY WE ARE VOTING “NO”
CORDATUS CAPITAL (PTY) LTD – JAN 2014
FUND NAME
Coronation Top 20 A
Nedgroup Inv Rainmaker A
Old Mutual Investors R
Foord Equity R
STANLIB MM Equity A1
Coronation Equity R
Investec Equity R
Oasis Crescent Equity D
Prudential Dividend Maximiser A
SIM General Equity R
SIZE
22 066 545 042
15 931 163 986
12 046 427 841
11 010 862 707
10 893 833 579
7 429 098 473
6 923 362 005
6 365 821 567
5 328 007 294
5 301 140 272
TOP 10 (EXCL AG)
% OF SECTOR
103 296 262 766
54.0
OFFSHORE
NO
NO
NO
NO
NO
NO
NO
NO
YES
YES
BENCHMARK
FTSE/JSE TOP40
SECTOR AVERAGE
FTSE/JSE SWIX
FTSE/JSE ALSI
SECTOR AVERAGE
FTSE/JSE SWIX
FTSE/JSE ALSI
SECTOR AVERAGE
SECTOR AVERAGE
FTSE/JSE ALSI
Proposed change #3: Change in fund fee structure
AG is proposing the following
•
•
•
•
A reduction in the base fee from 1.5% to 1% per annum.
The uncapping of performance fees from a 3% cap.
A change in the measurement period from rolling 2 years to daily with a high watermark.
The sharing rate to be increased from 10% to 20%.
While reducing the base fee is always welcome from big funds (after all, the cost structure of the
fund does not change), the uncapping of performance fees is not, as the distinction between fair
reward, greed and avarice is poorly defined as a result. The biggest problem we have with the
increase in the sharing rate (a misnomer if there ever was one – believe me, they are not giving
you anything!) is that the new benchmark now plays a very important part in the calculation.
Namely, AG is now asking you to pay them 1% if they perform in line with the weighted sector
average (comprising 139 funds currently). Surely you invest with a company in the belief that they
are better than average and are applying their best efforts at all times! Evidently this is not the
case, in that you are now being asked to reward (with no limits) AG if they just do better than
average. Somewhere along the line all reference to the JSE All Share index will be lost and just
what do you use as your reference point in future? Imagine if all the managers in the sector had
the sector average as a benchmark? The mind boggles at the mediocrity this would encourage.
Proposed change #4: Inclusion of derivatives
We wholeheartedly support this alteration to the Trust Deed. The ability to undertake nonspeculating hedging positions and alter market/instrument exposure inexpensively is always
welcome.
AGEF: WHY WE ARE VOTING “NO”
CORDATUS CAPITAL (PTY) LTD – JAN 2014
In summation
The only way we could vote in favour of this ballot was if the proposals on these 4 items were;
•
•
•
•
#1:
The 30% direct offshore exposure was not proposed. The fund remains SA equity
centric.
#2:
The benchmark remained relevant to investors (the FTSE/JSE All Share Index TR).
#3:
The performance fees remained capped, regardless of the sharing rate and dubious
reference point for calculating the “gun & mask” level.
#4:
Derivatives were included (this is the only proposed change that makes sense to us
as allows for limited protection and off market adjustments).
Thus, if you are a larger investor where you self-direct manager, asset class and offshore
allocations, then you are not being well served by these proposals in our view. Focus within
diversification should always be advocated for the successful long-term investor with a defined risk
/ return target wealth objective.
At an Allan Gray presentation on 28th October 2014 in their fantastic new auditorium the large
audience (primarily IFA’s) was asked whether they would support these proposals. I did not count
hands but would confidently predict (given the look on the faces of AG personnel) that in excess of
90% of the audience said NO. The problem is, it does not matter what we think, as, for a ballot to
pass you only need >50% of a minimum of 25% of unit holders for a resolution to pass. Thus
12.5% of units will be able to make this decision for the rest of us. Given that many investors in the
AGEF are institutions (either controlled or directed), I would hazard a guess that the ballot is a
mere formality.
What to do if you want out?
Not agreeing with AG on these proposals is one thing, voting with your feet could however be a
very costly option to pursue given your embedded unrealised capital gain within the fund.
Fortunately, we have mechanisms to help you in this regard and should you wish to find out more,
give us a shout.
CRAIG McKAY
28 January 2015
AGEF: WHY WE ARE VOTING “NO”
CORDATUS CAPITAL (PTY) LTD – JAN 2014