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Thursday 22 June 2017

Allan Gray, Meet Bill Miller

Allan Gray or Grey Allan? 
Allan Gray is a company which is synonymous with Unit Trusts in South Africa. So much so, that even those with zero interest in personal finance are bound to have heard the name.

The company was founded in 1973, making it one of the oldest (and arguably most successful) fund managers in South Africa. A remarkable success story.

Compare this to Bill MiIller - whom I am sure none of you have heard of?

Allan Gray

The Allan Gray General Equity Fund was launched in October 1998 - so it is close on 20 years old. Over this period, it's track record has been nothing short of astounding. I had a look at the fund's MDD for May 2017 (you can find the latest MDD here) and pulled some pictures and numbers.

The graph below shows how investors in this fund have significantly outperformed the benchmark (the benchmark has, for the most part, been the JSE All Share Index, but recently Allan Gray changed it to the average return of general equity funds - more on this later). R10 invested when the fund launched would have grown into over R500 today.

Red line clearly above the grey one

The numbers for various historic periods are summarised below:

What!? An active fund ahead of the benchmark over 10 years!?

Credit where credit is due - that is a hugely impressive track record which very few asset managers can come close to. This makes it very difficult to try talk anyone out of investing into the Allan Gray General Equity (or their Balanced Fund for that matter). What a fantastic track record!

Naturally a fund that is performing well attracts inflows, and there is now around R40.5 Billion in the Allan Gray General Equity Fund. (To give some perspective, that is roughly the same as the entire market cap of Mr Price! Massive.)

With a current TER of 2.34% (most of that is due to performance fees) a quick back of the matchbox calculation reveals that the fund brought in a cool R948 Million in revenue for Allan Gray - i.e. nearly a Billion rand. Ching ching.

Bill Miller

So who is this Bill Miller bloke?

Bill Miller was the fund manager of the Legg Mason Value Trust in America. - another truly remarkable fund.

Rewind a few years, to around mid-2000, and the fund had not only beaten the S&P 500 over a 15 year period, but for each and every year, over a 15 year period the fund had beaten the benchmark. Not a single year of underperformance over that period.

This awe inspiring feat lead to Fortune magazine, in 2006, calling Bill Miller the "greatest money manager of our time". There was finally an active manager who seemed to hold the secret to consistent long term outperformance.

And then....

In 2008/9, the fund got absolutely walloped. Smack!

Ok, fair enough, during the financial crisis pretty much everybody suffered - so maybe some underperformance was to be expected. What about the year after that? Well, not much better. And the same goes for every year after that.

And if you look at the fund from the beginning until the present day - it has underperformed the benchmark, despite the astounding 15 year stretch in the middle.

So it basically all came crashing down in a big heap. In true Japanese style, Bill Miller decided to call it quits and step down from managing the fund in April 2012.

Allan Gray, Meet Bill Miller

So is the Allan Gray General Equity Fund doomed to go the same way as Bill Miller's fund? Unfortunately my crystal ball has malfunctioned pretty much from the day I got it, and so I cannot give you a straight answer.

But worth keeping in mind, is some research (U.S. based), which basically says that any fund that outperforms over an extended period of time will more than likely just revert to the mean, and some other fund will start to outperform.

Jack Bogle (father of Index Tracking and Passive Investing) in a recent interview, presented some interesting statistics. Over a 5 year period, active funds in the top quintile of performers were more likely to be in the bottom quintile (24% chance) over the next 5 years than to remain in the top quintile (only 16% chance). I.e. more chance to go from top to bottom than to stay at the top.

What is also quite scary is that 13% of the top performers over a 5 year period were either shut down or merged.

I hacked the following table from the article:

Don't worry I had to Google quintile too!

Also interesting to note is that the bottom performers over 5 years were more likely to end up as one of the top performers of the next 5 years (15% chance) than to remain as one of the bottom performers (9% chance). It does make you wonder how much of performance is due to luck and how much of it is skill?
I guess you can make your own mind up about that...

It is entirely possible that the Allan Gray General Equity Fund will carry on outperforming. But bear in mind that it is also very possible (and maybe even more likely) that it won't.

And of course any underperformance may not happen for another couple of years, (in which case I will get a lot of told you so's), But then again it could already be happening - the fund has underperformed the market over the last 6 months (at the time of writing, the JSE All Share is up 2.08% while the Allan Gray General Equity Fund is up 1.38%. By the way you can check the performance of all the Unit Trusts in South Africa at FundsData Online - pretty handy!)

The problem is, you will only know that Allan Gray has underperformed over a 5 year period, after, well, 5 years. And by then you could already be well behind the index tracking curve.

But, in my opinion, maybe one of the the surest ways to tell that not even Allan Gray are that confident that they will be able to keep up the fantastic run they have had, is the fact that they have changed their benchmark.

For years Allan Gray measured their performance against the All Share Index. This seems fair enough - a fund that invests in local equities should be aiming to beat a local equity index. But then, effective March 2015, they decided that it would be better to measure themselves against the average of all the local equity Unit Trusts.

Now why would they do this?

Their full explanation can be found here.

In short, what they are saying is "Well we want to invest a portion of the fund overseas. So now the local index is not that relevant anymore. But hey, some of the other local funds also invest overseas. So let's just measure ourselves against the average of all the other General Equity Funds."

Of course what they could and should have created a new benchmark consisting of x% of an overseas based index and (100-x)% of a local equity index - where x% is the maximum amount their mandate allows them to invest internationally.

Why didn't they do this? Well here is a fun fact:

The average General Equity Unit Trust will underperform a relevant index based benchmark. 

So this new benchmark really suits Allan Gray because:
a) The benchmark is now lower down, which means
b) There is a higher probability that performance fees will be payable (ching, ching) and
c) It will be easier to outperform and therefore maintain their "outperformance" streak

In my opinion, changing their benchmark to an average of their peers seems to say - "Well we know we might be above average, but we probably not going to be able to continue beating the market because there is a tonne of research saying this is highly unlikely. So let's just lower the benchmark and then we can still generate some epic performance fees, even though we are not really performing."

Something to think about...

To Wrap This All Up

First word of caution:
The next time you are tempted to invest in the "next great asset manager" think of Bill Miller and just go with an index tracker....

Second word of caution:
If your Unit Trust manager wants to change their benchmark, always ask why and in whose interest the new benchmark really is...

*Just to be clear, I am not picking on Allan Gray, they just happen to be the current flavour of week in the asset manager space. Over time this could change to Coronation, or Investec, or Foord, or Stanlib (seems to be more or less equal probability of any of these becoming the next big thing...)

Till next time, Stay Stealthy!
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