ALUWANI’s domestic equities investment and portfolio construction process is benchmark cognisant and aims to generate risk-adjusted returns over any client chosen benchmark index over time. We do not only focus on chasing returns, but we are equally aware of the risks we are taking in pursuit of such returns, i.e. benchmark relative risk. Being benchmark cognisant also means that our process is scalable as we can leverage our stock selection views and construct portfolios that aim to exceed client expectations.

It is therefore important as investment professionals to understand the characteristics of each benchmark that we are being measured on, equally so for the end client to do likewise, especially since of late these varying indices have experienced material performance divergence.

1. As can be seen below, performance diversion was particularly stark for the one year ending 30th April 2019, where the best-performing equity index was almost 5% vs the worst at almost negative 2%, a 7% variance! Over a slightly longer period of 3 years, the variance equates to 4%. Based purely on benchmark choice, an index tracker investor who chose Capped Swix would have lagged the other tracker investor who chose Top40 by 4% per annum over three years. It would also be unlikely that stock selection through active portfolio management would have made up for the difference in these benchmarks without taking material active positions. For instance, any active position placed on the benchmark would have to contend with the sizable difference in the Naspers weight between the indices. As of 30 April, the weight of Naspers in Top 40 was 25%, compared to 11% in Capped SWIX.
2. The same argument can be done from a risk perspective. Defining risk as the standard deviation of active returns (or tracking error) we can see that there was substantial tracking error between the various indices. The deviation in active returns between Capped SWIX and SWIX 40 was as high as 6.7%!

3. Equity risk premium is the compensation required by equity investors not to be invested in risk-free yielding assets, such as guaranteed government bonds. Textbook and conventional thinking suggests that a measure of this risk premium is the difference in earnings from equities vs bonds and over the long term this has been calculated at around 4,5% extra earnings (premium) equity investors would need to earn in addition to bond yields, to be indifferent between the two asset classes. From the chart below, the few odd times such conventional thinking held true was during the global financial crisis where such differential was approximately 7%, i.e. equity investors being more than adequately rewarded for investing in equities vs bonds. Since then, this conventional relationship has been inverted, and upon closer inspection, the sad reality is that the domestic equities market has not generated enough earnings despite positive returns, and that is largely due to price expansion (in the hope of earnings to come, but still remaining elusive).

CONCLUSION

Perhaps it is now opportune for investors to approach the South African domestic listed equities more from a stock selection point of view as opposed to it being an asset class, with an absolute return and volatility targets as desired outcomes. Even though at ALUWANI our process is benchmark cognisant, we appreciate and accept that none of our benchmarks are ‘perfect’. For investors, over and above taking risk by investing in equities (without the appropriate reward, as shown above), why take additional risk by selecting one benchmark vs another especially since the differences can be this stark?


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