The third quarter of 2011 was not much fun for Investec Asset Management. Of the 14 main strategies across its five product streams - ‘4Factor’ equities, contrarian equities, multi-asset, commodities & resources and fixed income & currencies - only two beat their benchmarks. One, Global Commodities & Resources, lagged by 11.4%. Over 12 months, only four out of 14 have outperformed.
But look at the longer-term picture. Over three years 12, outperformed, as did eight out of 10 over five years, and every single one has outperformed since inception. One has delivered a staggering 9.5% annualised excess return since launching in January 2007. Which one? Global Commodities & Resources. Alpha - true alpha - can be negative as well as positive. If you are persuaded that it is alpha, it will pay to hang on through the rough parts of the ride.
“We want to identify structural beta on a 10-20-year horizon and then add excess alpha,” says CEO Hendrik du Toit. “I don’t have any worries about the alpha, but the concern is that clients run away when the beta fails. That’s one reason why we are focusing on the top end of the investor base in every market except our two domestic ones, Southern Africa and the UK. We have found some really special clients in Europe, particularly Scandinavia, who take a long-term view that recognises the fallibility of the short-term.”
Du Toit speaks with authority about the long view. He was there at the founding of Investec AM in 1991 and has built it organically. Within Investec, while both investment banking and wealth management have happily grown, and continue to grow, by acquisition, asset management has only acquired a ready-made team once, and never a fully-fledged business.
“We are the only firm I know that has successfully migrated from the Southern Hemisphere - let alone Africa - to build a competitive global position in institutional active asset management without a string of acquisitions,” says Du Toit. “We have a build-it-from-scratch mentality and think we do it really well. That means believing in what the firm stands for and being in it for the long haul, which involves a lot of work on our common values and culture - after all, you spend more time at work than with your wife and kids.”
As Du Toit implies, Investec AM staffers need to buy into the culture because their teams will spend five years building a track record before their boss will consider the 5-10-year journey of taking their concept to market and building its scale. That 10-15-year time scale means that the firm now has a nice range of products firing on all cylinders, just at the time when the Investec group is planning to balance its business away from investment banking and towards wealth and asset management (their share of group earnings and operating profits is up more than 50% on 2010 levels.
That requires a growth strategy. The source of that growth might be surprising, given the firm’s emerging market roots and investment specialism.
“Number one: the US. Number two: Europe,” says Du Toit. “And about five years ago we decided that we really wanted to deal with the upper end of the global institutional market. Asset management is all about introducing pools of savings to the markets that offer the opportunities to make them grow, and 85% of the world’s institutional assets is controlled out of those two regions.”
This contrasts with what a lot of other asset managers say about the move to individual retirement provision and decumulation as collective schemes close down and populations age in the developed world, and the contrasting potential for demand for investment products from the emerging world. Du Toit doesn’t disagree, necessarily. He merely warns that pretenders to the small pool of emerging market savings will have to compete against locals.
“You can ask a certain well-known UK asset manager who came to South Africa and left with a bloody nose,” he says. “Many overestimate the opportunities coming from emerging markets.”
He also points out that, as a non-incumbent, Investec has a lot of room to grow in Europe, and that only long-established, super-large institutions can continue to take risk. (Interestingly, he sees the UK as a key wealth management and family office market, but not a compelling pensions market, because it is too fragmented).
Moreover, those institutions are already taking risk, in terms of globalising their portfolios, and Investec AM’s recent asset flows follow that theme: Q2 and Q3 of 2011 saw a total of £1.8bn (€2.1bn) flow in from institutional investors, and the strategies of choice included emerging market debt and Asia ex-Japan and emerging market equities. “The global equity game - moving away from home-bias - is really just starting, and we are global investors,” says Du Toit.
The fact that Du Toit sees the firm as a resolutely global investor explains the surprising fact that the emerging market equity strategy was only added to its range in April 2011. Contrast that with the fixed-income side of the business, where Investec was an early mover: while it was launching its first emerging equities product in April, it was adding two more emerging debt funds to its range - including EM corporates. Of course, it’s not that Investec didn’t manage emerging equities before; rather, it is so at home in the major emerging markets that it barely considers them separate from the global opportunity.
“In fixed income we believe that there is a genuinely emerging market,” says Du Toit. “Even the BRICs haven’t yet developed mature capital markets. Issuance is catching up with investor demand; the sovereigns are generally solvent and creditworthy; the corporates are rated below their true creditworthiness simply because of their location; and the currencies are benefiting from a broadening of currency portfolios. Since 2009, we have had an explosion of demand.”
In equities, however, Investec wanted to establish itself as a truly global manager.
“We still think global equities is the big growth area, and where alpha is available most freely over time,” says Du Toit, “but clients continue to separate these things somewhat artificially. We carved out EM in response to client demand and the fact that capacity has become limited as competitors closed to new money. But where do we see the real action? Among the bottom two billion of the population - where indices aren’t well-developed, where it’s more difficult to invest and requires higher diligence, with less liquidity, but far away from any sovereign or banking stresses. We started building on that from our Africa strength - which is now well-understood and mastered by us as the ultimate frontier.”
Du Toit says that these frontier markets are a different proposition altogether from global emerging. It shouldn’t be treated as an asset class, he says. And that goes beyond arguing for active stockpicking. He advocates more of a private-markets approach, which can invest across the capital structures of portfolio companies.
This is very different from the contrarian and ‘4Factor’ styles that drive Investec’s public equity strategies at the moment (4Factor is a bottom-up, discretionary approach, but deploys a rigorously exclusive screen of companies’ management strategy, valuation, share-price momentum and earnings-revision trends).
Du Toit likes the variety and flexibility. Three different equity styles generate three different perspectives that can be shared firm-wide, he notes, and (as with the emerging equities carve-out) it helps to respond to gradually evolving client demand. “Even some sophisticated institutions look at our aggressive active products - ‘Ah, you do private equity, great’ - but then come back and ask to buy our Africa liquid product because they’re not quite ready,” he says.
But he also has a clear vision of where he wants to go - global and high-alpha in 4Factor and contrarian (“Core is available but not in the shop window,” he says); and growth markets.
“Investors need to be careful not to overdo the de-risking,” he warns. “We are predicting a need for capital gains and alpha from those who are being advised to de-risk and decumulate. We mustn’t lose touch with risk and return: there will always be a place for quality capital gains.”