The Metropolitan Cautious Fund: A fund to consider in uncertain markets

The Metropolitan Cautious Fund is classified in the AA Prudential Low sector, which means the fund manager should have no more than 40% in equities (including international). The R25 million fund has been managed by Eugene Goosen since April 2009. The fund is the leading fund over rolling 12 months in the Domestic Asset Allocation Prudential Low Sector, with a performance of 21.78%*.

Please tell us about your investment experience.

I studied at the University of Johannesburg obtaining an Honours degree in investment management followed by an M Comm. I trained as a money market dealer at United Bank. Subsequent employers included ABSA Treasury, RMB Asset Management and Investec Asset Management.  I joined MetAM as Head: Dealing and Implementation in March 2005 and since September 2007, have taken on the role of Head of Alternative Strategies responsible, for all absolute return products and alternative strategies.

Benchmarks in the AA Prudential Low sector range from composite benchmarks, to CPI, to Bank Rate plus or Stefi Plus. Some of the benchmarks are CPIX + 4%, while your benchmark is CPI X + 3%. Please could you explain by way of an example, the difference in these benchmarks? What is Stefi + 3% right now for example, and what is CPIX + 3% right now.

The Stefi index is composed using money market rates or nominal interest rates. The index has yielded around 9.69% over the past 12 months thus the benchmark (Stefi + 3) would have yielded 12.69% over this period. CPIX is an inflation measure; Stats SA has recently revamped the indices and dropped the CPIX composition. We use CPI index now. CPI + 3 yielded 12.75% over the past year to the end of May 2009. An investor should strive to protect himself against inflation, thus we use inflation plus 3% as a basis to construct the portfolio. This should yield a 3% return above inflation over the medium to long term.

Do you think the different benchmarks in the sector cause fund managers to have a different investment philosophy? If for example, your benchmark was CPIX + 4, what changes would you make to your fund?

The aggression level or risk composition will increase as the required return above inflation increase. Our investment philosophy and process in the different risk categories is similar. The riskier fund will hold more equity and or credit to achieve the required objective.

The base annual fee of the fund is 1.14%; you also have a performance fee set at 10% of the outperformance above the portfolio benchmark over rolling 12 month period, capped at 1.25% p.a. Does this mean the total fee of the fund could be 2.39%, if you met your performance target?  

Yes, but our present total expense ratio (TER) is 1.14%; although fund has a performance fee, we are not levying one at this stage,

Your fund is mandated to use derivatives to protect the capital in the fund. Could you explain how you do this, which derivatives you use, bearing in mind your underlying holdings and how successful you have been in your timing decisions?

 We use equity index derivatives to protect the equity component. Timing investments is extremely difficult, that is why we use derivatives to assist us in the risk management of equity and where necessary other assets. We will buy assets that are priced attractively and hold on until they get expensive. However there are various other factors that drive the market over the medium term and that risk needs to be managed. As a conservative portfolio, our clients prefer to have fairly low volatility and the derivative instruments are used to assist us in achieving this.

Please explain the starting point of your portfolio construction process

The fund aims to outperform CPI + 3% on a rolling three year basis with minimum draw downs (negative performance).Our starting point is to forecast CPI over the next 12 to 18 months. This will guide us in the required return that the fund should deliver. Thereafter we forecast the expected asset class returns and the associated risk profile of each asset class. Within the fixed interest asset class we break the expected returns down into time-periods to refine our curve positioning.

In the shorter term, we have to seek extra ways of earning alpha in order to meet our target of CPI +3%. This would obviously not work over time and we therefore need to apply risk to achieve the required target. We therefore seek extract alpha from asset allocation, dynamic derivative management, bottom up equity selection and active fixed interest management, incorporating credit and duration management.

Please explain your equity selection process.

We use a multi factor model to assist us in the stock selection process. The model uses valuation and various other factors that explain a stock's return to select a preferred universe. The selected stocks are then optimized to construct a portfolio to ensure risk is efficiently allocated and well controlled.

Do you actively manage the fixed interest/ bond component of the fund?

We do manage the fixed interest process actively, we invest in the Metropolitan Income Plus Fund as a building block, which is currently used to expose the fund to selected fixed income and credit strategies. The manager of the fund, Brandon Quinn is also a member of the Alternative Strategies investment team.

What underlying holdings/ investment strategy has contributed to your recent 12 month outperformance?

The combination of equity and the hedging there off has added a lot of value, boosting the fund value but keeping the volatility at acceptable levels. Out credit strategy has also great value.

Is this strategy replicable in the current market?

We have a unique skill in derivative management, equity and fixed interest management, including credit. The ability to manage all this within one teal gives us lots of flexibility and we can quickly adapt to market conditions.

What is you outlook for the equity market for the next 12 to 24 months?

We still see reasonable value in the equity market. Currently, the rolled PE is around 11.4 times earnings. Given the stage of the cycle that we are currently we believe we could easily revert back to the long term mean of around 12 to 12.5 times earnings. This would give us upside potential of around 15% to 20%. This looks attractive compared to current real short-rates of -1% in the money market.

*According to EFS Investment Solutions data as of 08072009