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Three key investment mistakes to avoid

The current environment is an extremely testing one for fund managers. There is so much uncertainty on so many levels, that selecting appropriate investments takes both a lot of analysis and a lot of courage.

However, Paul Bosman, the co-manager of the PSG Balanced Fund, says that even in times like this it is possible to build robust portfolios that allow both the fund managers and investors to sleep well at night.

“Regardless of whether times are rosy or stormy, the three key mistakes to avoid remain the same,” Bosman says. “Don’t pay significantly more for something than it’s worth; don’t buy something just because it looks cheap; and don’t build highly correlated portfolios.”

To do this, however, you have to be able to look past the short term noise and appreciate the longer term fundamentals of what you are buying.

Understand the risks

Bosman points out that it is possible to manage risk by trying to work out what is already in the price of an asset. And when quality assets sell off, that doesn’t make them more risky, but less so.

“Even the worst of news can be priced into a stock,” says Bosman. “And if it’s already in the price, then it’s not such a risky investment.”

For example, South African banking stocks collapsed at the time of Nenegate last year and have largely remained depressed. Nedbank is basically trading flat over the last three years.

“There is a lot of bad news in the share price,” says Bosman, “but this is a quality business with good intrinsic growth, paying a 5% dividend yield.

“There can be further political challenges in the short run, but over the long term an investment is about competitive forces in the market,” he says. “Banking is not an easy industry to come into, and with all the noise in South Africa there aren’t a lot of people who want to try. So if you can buy this kind of business with inherent quality that the market is not pricing correctly, that is actually a low risk strategy.”

Be circumspect

However, Bosman does caution that just because there is strong negative sentiment in the market, doesn’t mean that everything that has sold off is now worth buying.

“Just because something is down, doesn’t mean that it’s cheap,” he says. “You still need to look for inherent quality that’s worth paying for.”

When adding assets into a portfolio, you also have to be aware of how they are likely to move in relation to each other. Especially when building bottom up portfolios, there is the risk of ending up with assets that are highly correlated as it is likely that the stocks that are currently attractively-priced, may have all sold off for similar reasons.

“You have to try to balance this,” Bosman explains. “At PSG we follow a bottom-up process, but are very aware of having too much unintended correlation because you don’t want the whole portfolio to perform strongly only in one kind of environment and poorly in another.”

In the same vein, it is very important not to construct a portfolio around a single outcome.

“You can draw parallels between building a portfolio and going to the supermarket,” Bosman says. “If you only go to the supermarket to buy things that you will need in a world war three scenario you are going to be pretty well stocked up on canned food. Whereas if go and you do your regular shopping, but also buy food for the kind of circumstances that might stop you from going to the supermarket in the future, such as a world war, you will have that canned food in the pantry, but you haven’t built your lifestyle around it. So when you need it it’s there, but you aren’t only eating baked beans.”

For instance, he points out that nobody can know with 100% certainty that South Africa’s credit rating will be downgraded. So it would be irrational to build 100% of a portfolio around this outcome.

“But if you think there is a 30% that we will be downgraded and you can build 30% of your portfolio accordingly, that’s rational,” he says.

PSG therefore does hold a lot of cash at the moment as security against a worst-case scenario, but it is also willing to use that cash when opportunities present themselves.

“That cash can become very powerful when quality assets are selling off,” Bosman says. “We only allocate money when we find an opportunity that is compelling. At the moment across our portfolios we are very happy to sit in cash, and so we don’t mind when the market sells off because that creates opportunities we can enjoy.”