Citadel is driven by four investment pillars which govern the protocols around how we invest and preserve your wealth, the central tenet is to ensure that turbulence of any form does not equate to a permanent loss of capital.
Speaking at a recent Annual Client Presentation, Citadel’s Chief Economist and Advisory Partner, Maarten Ackerman, said: “In our business, what is success? It’s client retention. And how do you keep your clients? You don’t lose their capital. So avoiding permanent capital loss is crucial.”
Ackerman put Citadel’s investment pillars into context in the current environment by highlighting the solid foundation and protocols which underpin the Citadel investment approach.
PILLAR ONE: THE FUTURE IS UNCERTAIN AND WILL OFTEN SURPRISE
We believe the future is always uncertain and impossible to predict. Often economic or other events will take investors by surprise, throwing investment strategies which are based on a single future scenario into complete disarray. If these uncertainties are built into the portfolio construction process upfront then such unforeseen events should not throw the investment strategy off course and emotions can, therefore, be kept out of the process.
How do you prepare your portfolio to handle not only uncertainty, but also dramatic and unexpected events? You ask: “What if?”
Ackerman explained: “We always ask the question ‘what if?’ What if Brexit turns our slightly different? Do we have asset classes in the portfolio that can make money and protect that money?”
The debate around South African exposure is one such “what if?” question. “We are currently underweight South Africa, not because we are negative about the country, simply because we can buy better companies abroad and pay less for them and they operate in economies that are growing faster,” said Ackerman. “But we do look at this ‘what if’ environment. What if we see investment coming in stronger, reforms take place and five years down the line the JSE is doing much better than global markets? What do we do today to prepare for such a scenario?”
PILLAR TWO: DIVERSIFICATION REALLY IMPROVES YOUR RISK RETURN
A portfolio that consists of a range of asset classes, or sources of return that perform positively in different market circumstances, is robust and should preserve and grow wealth consistently.
While the value of diversification has become a commonplace investment belief, Ackerman points out that where Citadel stands out is the extent of its diversification in tougher market environments. This keeps returns on track, but reduces risk.
Ackerman explained: “You can take your money and put it in the JSE (from 1995 to date) and the market will go up and down and today you’ll have made about 15% per annum on the JSE with a risk fluctuation of about 20%. You can take that same R100 and put it into US bonds and, measuring it in rands, over the same time period you’ve made around 12%, which isn’t that different to what you made on the JSE with around the same risk (about 19%). But these two assets behave differently when there is stress in the system. When there is a crisis, and the JSE is at the bottom, US bonds are flying. Having more of these kinds of asset classes, which behave differently in different cycles, that’s when you start to improve your portfolio. If you look at most of our client portfolios, we have a lot of diversification.”
PILLAR THREE: VALUE INVESTING MAKES SENSE
Every asset class or investment has an economic value. This economic value does not fluctuate greatly over time. Market perceptions of the economic value of asset classes, however, typically fluctuate strongly. In the real world, market prices often diverge from economic value. We base our investment decisions on this under- and over-valuation of asset classes.
In other words, don’t pay too much for any investment opportunity, because it will take years to make back the money.
Ackerman explained: “Look at global equity markets and at price earnings (PE) ratios [the price you pay for the earnings] at the beginning of the period and what return you’ve made five years down the line. You can see from that, the lower the PE the higher the potential return. So don’t overpay.”
Over 120 years of stock market returns show us that a low PE is around 10, meaning you are getting the same amount of earnings for less, an average PE is around 10 to 22 and a PE of 23 is high.
“Don’t get into the market, like just before the Nasdaq bubble when PE ratios north of 30 still saw ordinary investors getting pulled into the market; you will not make the money back,” stressed Ackerman. “Similarly with Bitcoin, everyone who got onto the bandwagon when things were flying saw a permanent loss of capital. The good news is that most markets today are somewhere in the average; so you are not paying too much for great companies and adding them to your portfolio.”
PILLAR FOUR: ASSET ALLOCATION DRIVES PERFORMANCE
Numerous studies have shown that the majority of investment returns can be attributed to the asset allocation decision.
Ultimately your financial plan drives your performance. This is where the advice and the asset management sides of the business start to dovetail.
“This is when we do the simple calculations and say if you don’t need this money for 10 years then it belongs in that long-term growth bucket,” said Ackerman. “In this case, you can let companies around the world work on your behalf and make you money.”
What will not evaporate is the market volatility over this period. Yes, there will be volatility and, yes, your portfolio will experience this, but when you are dealing with long-term money this is factored in. The funds you need in the short- and medium-term are ringfenced into stable or prudent baskets.
Pillar four starts with a conversation and an understanding of your needs. And this approach underlines each step of the process.