‘Keep It Real’ - A Gryphon Op-Ed Series: Part 4 of 5
There seems to have been a resurgence in the fascination with the mythological – movies like Lord of the Rings and Game of Thrones are testimony to this.
In ancient Greece, stories about gods and goddesses, heroes and monsters were widely accepted as part of everyday life. Everything from being struck down by, and recovery from, illness to getting great seats for the circus (i.e. not being the main event in the arena) was attributed to them. They gave meaning to the world people saw around them.
The purpose of this opening is to introduce the fourth of our five part series: ‘Keep It Real’. The series is an attempt to demystify the mythical, mysterious world of investing. Pension fund reforms have shifted responsibility and liability in the world of employees and trustees and made understanding investment options and choices essential.
In Greek mythology, Icarus is the son of the master craftsman Daedalus, the creator of the Labyrinth. Icarus and his father attempt to escape from Crete by means of wings that his father constructed from feathers and wax. Icarus' father warns him first of complacency and then of hubris, asking that he fly neither too low nor too high, so that the sea's dampness would not clog his wings, nor would the sun's heat melt them. Icarus ignored his father's instructions not to fly too close to the sun; when the wax in his wings melted, he tumbled out of the sky and fell into the sea where he drowned, giving rise to the idiom "don't fly too close to the sun".
Complacency and hubris are emotions experienced not only by Icarus, but also by many investors. While this story from Greek mythology may be considered by some as being far removed from modern-day financial markets, we beg to differ. At Gryphon we believe it accurately describes not only the behaviours to be avoided, but also explains how investors need to navigate between the ‘dampness of the sea’, i.e. exposing themselves to insufficient risk to avoid their wealth being eroded by inflation, and the ‘sun’s heat’, i.e. overly-aggressive exposure to risk, which can have ruinous economic consequences.
The South African investment market has matured to the point where it is now generally accepted that, when it comes to stock picking, active asset managers struggle to consistently keep up with the index. As a matter of fact, over any time frame, far less than 50% of the active asset managers manage to outperform the index. This means that the odds are not even for beating the market; it is a loser’s game that even most gamblers would not entertain. Index tracking is the answer; efficient index tracking at a low cost. (We’ve covered this extensively in Keep it Real parts 2 and 3.)
Further to this, when investing in a single asset class such as equities, Gryphon believes that selecting the winning stocks is not all that is important in an investment strategy - in our experience, asset allocation adds more value than stock selection does. Equities is the asset class likely to generate inflation beating returns over the longer term and, when this asset classes offers value, our multi asset funds are fully exposed to equities. When this is no longer the case, and indications are that there is excessive risk in equities, protecting investors’ wealth becomes paramount and this will usually necessitate a move into cash.
This is a somewhat controversial perspective which provokes the eternal investment myth, “It is impossible to time the market”…
It is commonly pointed out that investors cannot afford to be out of the equity market at any given time because “we cannot read the market” and the market may run, and investors will then lose out on the market run. And thus, common practice is to sit through market downs, whether it’s only a correction or a more serious market crash, rather than be out of the market and risk missing out on the upturn.
The Gryphon investment philosophy supports the opinion that, in an efficient market like ours, as well as in sizable portfolios, it is easier, more reliable and consistent to add value through asset allocation (switching between equities and cash) than by stock selection. We believe it is possible to time the primary cycles of the market! That is, to time the market from an asset allocation perspective, not timing stock selection. Gryphon has developed a series of proprietary indicators that identify prevailing market conditions and thus dictate which action should be undertaken i.e. is it time to protect capital or is it time to generate growth?
Distinction should be drawn between primary and secondary cycles. Primary cycles are usually on average 5-7 years long; approximately 4-5 years of markets moving up (generally called bull markets), followed by a market crash which usually lasts 1-2 years (generally called bear markets). These bear market cycles or market crashes (commonly defined as >20% market drawdown) usually take about 2 years to return to pre-crash levels. This is as opposed to a market disturbance or secondary cycles which occurs during the bull market phases. The secondary down cycles are generally called corrections, with declines greater than 10% but less than 20%, are short in duration (rarely longer than 3months) and usually sentiment driven. The graph below illustrates the occurrences of bear markets in the SA equity market in the past.
Over time, and many cycles, the factors that most reliably drive markets have been identified, researched, implemented…and experienced in real life. What we’ve learned is that it is possible to reasonably consistently call the primary market cycles. Although it may also be possible to read the secondary market cycles, we have not yet been able to identify reliable factors that consistently predict these cycles accurately. As indicated, normally these secondary cycles are short in nature, around 3 months long and not more than 10% in size. These cycles are usually driven by greed and fear, and create a lot of noise in the market, but little direction. In this regard, we agree with the general thinking that the secondary cycles can be ignored rather than risking timing mistakes. The secret is to stand back and unemotionally invest according to the factors that have proved reliable in the past. By unfailingly sticking to the rules, recognising the factors that identify the primary cycle, this simple yet very effective strategy has delivered top decile performance.
Gryphon offers two multi asset funds whose primary objective is to generate real (after inflation) returns for investors at lowest possible cost. We believe that producing investment returns is a function of two broad actions, (1) protection and (2) generation.
Gryphon’s asset allocation decisions are bold. The funds are either fully invested in the asset class of choice or invested in cash. Towards the end of August 2018, these indicators signalled a lack of value and prescribed caution for the foreseeable future and, as a result, the funds moved from being 100% invested in equities into a 100% cash position and this is still our current position – our multi asset funds are fully invested in cash.
At the risk of being dramatic, the war against inflation and human nature is fought both at the top-of-the-cycle, when the temptation is to over-extend and over-stay, and at the bottom-of-the-cycle, when the temptation is to avoid because of fear and anxiety.
Below is a table detailing the performance of Gryphon’s multi asset funds against the return of the JSE as well as the average of money markets over the same 60 month period. We would credit the excess return to the ability to migrate between asset classes in the longer term.
Given the volatile, uncertain, complex and ambiguous state of this uncontrollable and unpredictable world, investment and broader, Gryphon’s tried, and tested strategy offers a harbour in the crazy storm.
In conclusion, a quotation from Sun Tzu, The Art of War:
“It is the unemotional, reserved, calm detached warrior who wins, not the hothead seeking vengeance and not the ambitious seeker of fortune.”
If you missed part 1, 2 or 3 of this series, click on the images below...