MPT teaches us that diversification is not solely a risk management exercise but a strategic advantage. By strategically diversifying across companies and asset classes, we mitigate portfolio volatility while preserving return potential. We achieve this through rigorous fundamental analysis of the markets, resulting in a clear risk and return perspective for each company and instrument we cover. This information is distilled into buy lists, which form the foundation of our monthly portfolio optimisation process, ensuring our clients’ portfolios target the highest possible returns within a robust risk framework.

Our approach goes beyond static models. We actively research, model, and value companies on a continuous basis while also monitoring global economic trends, interest rate shifts, and geopolitical developments to ensure our buy lists remain up to date. This monthly cadence allows us to adjust portfolios appropriately, ensuring that our clients remain on track to achieve their financial goals.

In this quarterly report, we demonstrate how we apply MPT, unpack the latest key performance drivers for the Northstar BCI Managed Fund, and outline our outlook for the months ahead.

Applying Modern Portfolio Theory?

Modern Portfolio Theory is based on the principle that portfolio stability is enhanced by combining uncorrelated portfolio holdings. For example, an unexpected increase in inflation may cause inflation-linked bonds to perform well while equities underperform. By holding both inflation-linked bonds and equities, returns can remain stable despite unforeseen inflationary pressures. Similarly, diversifying exposure to both local and global equities can significantly reduce portfolio volatility.

As shown in Chart 1, the average correlation between local equity (ZAR) and global equity (ZAR) is substantially below 100%, typically ranging between 0% and 60%.

Chart 1: 3 year rolling correlation – local equity vs. global equity

Source: Iress, Bloomberg and Northstar Asset Management (as at 31 January 2025)

The relatively low correlation between local and global equities significantly enhances the portfolio’s risk-adjusted returns, as demonstrated by the risk-return series for different blends shown in Chart 2.

Chart 2: Risk versus return for a blend of holdings in local and global equities (ZAR)

Source: Iress, Bloomberg and Northstar Asset Management (31 December 1959 to 31 January 2025)

Expanding on this principle, we integrate a full spectrum of asset classes represented by the suite of Northstar buy lists. These include buy lists for: 1) local equities, 2) global equities, 3) local fixed income, and 4) global fixed income. Armed with this data, we assess the optimal weightings for each asset class to ensure the best risk-adjusted returns. This computationally intensive process results in an optimized asset allocation for each Northstar multi-asset portfolio. Chart 3 illustrates the range of expected risks and returns based on the latest Northstar buy lists and the optimized positioning for the Northstar BCI Managed Fund.

Chart 3: Northstar BCI Managed Fund – optimised expected risk vs return

Source: Iress, Bloomberg and Northstar Asset Management (as at 28 February 2025)

Following the optimisation process, the target asset allocation (optimised BM) for the Northstar BCI Managed Fund as of 28 February 2025 is provided below.

Chart 4: Northstar BCI Managed Fund – asset allocation vs strategic benchmark and optimised benchmark

Source: Iress, Bloomberg and Northstar Asset Management (as at 28 February 2025)

Key performance drivers

Over the last quarter, the Northstar BCI Managed Fund benefited from a strategic shift in asset allocation, reducing exposure to local fixed income in favour of local equities, particularly by decreasing local fixed bond exposure. This adjustment came as the local bond market experienced strong gains following the 2024 elections, with bond yields trading below fair value.

Additional performance gains were driven by increased allocations to companies such as MTN, Naspers, Prosus, Goldfields, Richemont, and Anheuser-Busch, while avoiding exposure to Nvidia and Tesla and reducing exposure to Microsoft. Additionally, a meaningful allocation to USD cash and, more recently, US treasuries contributed positively to returns. The fund also achieved strong alpha generation in global stocks, delivering significant positive attribution versus the world index and even more so against the S&P 500.

Despite these strong relative gains, some detractors included increased exposure to local banks, industrials, and retailers. However, the fund sees compelling value in selected companies within these sectors and plans to further increase exposure in the coming months.

Outlook for Q2 2025

With local bond yields returning to fair value, the case for increased exposure is likely to come under scrutiny. However, inflation-linked bond yields remain attractive, offering strong real returns in an environment of persistent inflation, which should support favourable performance. At the same time, valuations in local cyclicals—including banks, insurers, retailers, property, and general industrials—are becoming increasingly compelling. As a result, our portfolio optimisation process is expected to maintain exposure to these opportunities, with the potential for further increases.

On the global front, equity valuations have recently become more attractive, likely drawing capital away from global cash and US treasuries, which have benefited from strong capital gains. Meanwhile, rising global uncertainties—including geopolitical tensions, the threat of tariffs, and signs of a weakening global economy—continue to create market volatility. To safeguard against potential market downturns, a portion of our local equity exposure is strategically hedged.

Through rigorous fundamental analysis of companies on our local and global equity buy lists, combined with a macroeconomic overlay and careful assessment of expected risk and return metrics, the Northstar multi-asset portfolios—such as the Northstar BCI Managed Fund—will continue to be optimised to achieve the best risk-adjusted returns in the most efficient manner.