Manager: Jan Mouton
Introduction
The PSG Flexible Fund has been under the stewardship of Jan Mouton since 1 November 2004. Before taking over the management of this Fund, he managed a hedge fund based on principles identified during his M.Phil in Finance that he completed at Cambridge University. Previously known as the PSG Tanzanite Flexible Fund, the PSG Flexible Fund was launched with a specific objective in mind: to provide its investors with equity-type returns, but at significantly lower levels of risk. Why is this important?
‘Equities give investors high returns over time, but also potentially expose investors to substantial losses’, says Jan Mouton. ‘For example, during the 2008 financial crisis, the FTSE/JSE All Share Index (ALSI) fell 45.4%. Many investors cannot stomach such a large loss and then act in panic at the wrong time. The flexible mandate of the PSG Flexible Fund attempts to limit the downside and risks that our clients are exposed to but still provide high returns.’
How we achieve the Fund’s objectives
The PSG Flexible Fund has two areas of focus: returns and risk management. To achieve and exceed the benchmark of inflation plus 6%, the Fund needs a significant allocation to equities – on average 75% since Jan Mouton took over management of the Fund. The manager is beholden to our Equity Investment Committee to search for companies that meet our stringent investment criteria (the 3 Ms): companies with a Moat (sustainable competitive advantage), good Management, and that are trading at an acceptable Margin of Safety so that the possibility of a permanent capital loss is lower.
Fundamental bottom-up analysis of the companies is crucial and each fund manager and analyst must really understand the investments that they analyse before making a recommendation to the Equity Investment Committee. ‘Not only are we looking at the companies on a nominal basis to see what their return prospects are, but we also look at them in relation to what we can get from cash. We focus on reducing the probability of loss, while still retaining good growth potential, that is, we get the odds in our favour,’ says Jan Mouton.
At PSG Asset Management, we are always looking to own high conviction ideas. We are therefore constantly reviewing all our options although we do not easily or frequently make changes. If you look at the PSG Flexible Fund from quarter to quarter – or even over years sometimes – you will see a high degree of consistency in the companies in the Fund.
In ‘The general theory of employment, interest and money’ (1936), John Maynard Keynes said: ‘The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this will focus the investor to direct his mind to the long-term prospects and to those only.’
It would follow that if, in the Fund, patience and discipline are required for us to achieve the returns that we have and want to continue to generate for our investors, then too investors in the Fund should follow the same approach.
The important role of cash in the PSG Flexible Fund
In the PSG Flexible Fund, cash is used both as a shield, and as a sword. If you cast your mind back to the last part of 2007 into 2008, you will recall that both local and global markets had run hard and valuations became stretched across the board. During this time we found fewer and fewer companies that met our investment criteria. As a consequence of that, our cash holdings began to grow as the companies in the Fund began to reach and exceed their intrinsic values and there were no attractive replacements.
At the end of May 2008, the price-earnings (PE) ratio of the ALSI sat at 15.87 times and the cash holdings of the PSG Flexible Fund were averaging 20% of the Fund. A short nine months later, at the end of March 2009, the PE of the ALSI had fallen by just over 48% and the average cash holdings in the Fund had fallen to less than 6%.
From its high in May 2008, the ALSI fell by 45.4%, while the PSG Flexible Fund only fell by 27.3% from its high. This significantly smaller decline was, in part, because the Fund owned quality stocks that declined less than the market. However, more significantly, it was because when the average stock was plummeting, the investors in the Fund were getting a positive return from cash, which was acting like a shield against the decline in equity values.
As the market fell and company valuations reached attractive levels, we purchased some great companies at exceptional valuations. We deployed the cash that had been serving as protection into companies, which, as the dust settled, produced strong returns for our investors. Between the end of February 2009 and the end of August 2009, the holdings in the PSG Flexible Fund performed strongly and the Fund reached a new high after 15 months. It took the ALSI 30 months to reach its pre-correction high. This proves that cash can have attacking or sword-like characteristics when it is used to buy companies at low valuations that, in the fullness of time, produce handsome returns.
The Fund’s holdings are generally quite different to the ALSI and most other local managers
In the PSG Flexible Fund, the application of our investment process has the outcome that we build our portfolios from the bottom up – basing our investment decisions purely on our 3 M investment philosophy. We do not take a share’s weighting in an index into consideration when we invest.
South Africa does not have a large number of companies from which managers can choose and if one looks at the large cap companies, this is an even smaller group. Those domestic managers – particularly those who are managing large sums of local equities – have a significantly more difficult set of choices than we have at PSG Asset Management, as the number of shares they can easily and quickly invest in and disinvest from is so limited. By being able to invest outside the top 40 largest companies in South Africa, we are able to give our investors access to companies that many of our peers cannot.
By design, we have chosen to look not only at South Africa- listed companies, but also companies listed on global exchanges. This means that we can give the Fund’s investors geographical diversification as well as diversification into sectors that are not represented on the JSE. In addition, there have been times – and we probably find ourselves in a scenario like this right now – where the average local share is quite expensive, but we are able to find foreign companies that are trading on attractive multiples and meet our 3 Ms.
Advice to investors in the PSG Flexible Fund and those considering investing in it
Firstly, invest for the long term. This Fund is not a fund for trying to make a quick buck. Just as we take a long-term view on all our investments that we make in the Fund, so too should investors take a long-term (three to five years) view when investing in it.
Secondly, investing requires patience and discipline. Just as we are required to stick to our investment process in a disciplined way and to have the patience to allow the companies in which we have invested to produce the returns we expect from them, so should investors follow a patient and disciplined approach to their fund selections. For example, when markets are falling and company valuations are becoming cheaper, we tend to buy these companies, allocating our cash to them, not pulling our investments from them. So should disciplined and patient investors ensure that if markets are falling they do not disinvest from the Fund and pull their cash. They should realise that these corrections are the times when future returns will be acquired and they should remain resolute and invested.
Thirdly, investors should consider the PSG Flexible Fund as a way to co-invest with a manager who is personally invested in the Fund.
In turn, we take the cash in the Fund and allocate it to companies that we believe have good management, a sustainable business model and where the price of the company is trading at an attractive margin of safety. We are particularly attracted to those companies in which their management have significant equity holdings themselves as that is also a strong indicator of an appropriate alignment of interests in the long-term success of the company.
Summary
Be disciplined in your investment approach and take a long- term view. Appreciate that, as an investor in the PSG Flexible Fund and therefore in the companies that the Fund owns, there is a strong alignment between the future success of the companies and your own prospects.
Lessons learned
Jan Mouton has been managing the PSG Flexible Fund for a significant period of nearly 10 years and through many different market conditions. He shared 10 lessons that he has learned from managing the Fund over the last decade:
- You need an investment philosophy.
- You need a flexible approach to asset allocation – wait for the right opportunities.
- Stick with your investment philosophy, even when it is not working.
- Follow a bottom-up approach: focus on companies, not the economy.
- Invest in companies where management are large shareholders.
- Reduce risk through global diversification in undervalued shares.
- Focus on shares with a low PE ratio
- Focus on shares with a low price-to-book ratio.
- Avoid large losses.
- Invest for the long term.
