MUS­CLES

Flex your flex­i­ble fund looks at whether mul­ti­as­set class schemes of­fer a real so­lu­tion to risk man­age­ment

CityPress - - Tenders -

The buy-and-hold in­vest­ment phi­los­o­phy, upon which War­ren Buf­fett built his for­tunes, main­tains that the key to suc­cess­ful in­vest­ing is to iden­tify a good, qual­ity com­pany, buy shares at a rea­son­able price and then hold them over time, ir­re­spec­tive of short-term mar­ket re­turns. The counter-ar­gu­ment to this is tac­ti­cal as­set al­lo­ca­tion, which is where in­vestors aim to buy when the mar­ket is cheap and sell when it is high. The prob­lem is that for most in­vestors, this “mar­ket tim­ing” of­ten re­sults in more losses than gains.

Re­search has shown that many in­vestors’ in­di­vid­ual fund re­turns un­der­per­form the fund they are in­vested in be­cause they try to time the mar­ket.

A study car­ried out by fi­nan­cial ser­vices com­pany Ac­sis found that, on av­er­age, in­vestor re­turns were less than the af­ter-costs re­turn of the fund they were in­vested in. Over the pe­riod of the study, Ac­sis found that the av­er­age fund in South Africa de­liv­ered an an­nual re­turn of 9.4%, while the av­er­age in­vestor only re­ceived 4.1% – the rea­son for this was that in­vestors con­tin­u­ally tried to time the mar­ket.

When the mar­ket falls and losses have oc­curred, in­vestors get ner­vous and cash in their money. Then the mar­ket re­cov­ers and, once ev­ery­one is feel­ing more com­fort­able, they rein­vest their money, usu­ally at a higher price than they sold it for.

While DIY mar­ket tim­ing may not work, another op­tion is to in­vest in a fund where an ex­pe­ri­enced fund man­ager is mak­ing those mar­ket-tim­ing de­ci­sions, hope­fully with more in­for­ma­tion and less emo­tion.

Flex­i­ble funds fall un­der the mul­ti­as­set class of col­lec­tive in­vest­ment schemes (unit trusts) and the fund man­ager is al­lowed to in­vest in any as­set class, de­pend­ing on their view of the mar­ket. Un­like an eq­uity fund, which has to hold at least 80% in eq­ui­ties at all times, a flex­i­ble fund man­ager can the­o­ret­i­cally hold zero eq­ui­ties.

Com­par­ing top-per­form­ing eq­uity funds with equiv­a­lent flex­i­ble funds, Fran­cis Marais, re­search and in­vest­ment an­a­lyst at Glacier by San­lam, found that flex­i­ble funds out­per­formed their gen­eral eq­uity peers over time.

What was in­ter­est­ing was that Marais found that, on av­er­age, the flex­i­ble funds had less ex­po­sure to eq­ui­ties, but had per­formed bet­ter. Con­sid­er­ing that, over time, eq­ui­ties out­per­form cash, why would flex­i­ble funds out­per­form?

The prob­lem with pure eq­uity funds is that, given the man­date, even if a fund man­ager is see­ing lit­tle value in the mar­ket or is strug­gling to find shares they would like to in­vest in, they are still forced to hold eq­ui­ties, even if they be­lieve they are over­pay­ing for the as­set.

In con­trast, a flex­i­ble fund man­ager can sit with cash or bonds if they can­not find com­pa­nies they want to in­vest in, so, when the mar­ket cor­rects or share prices fall and cre­ate value op­por­tu­ni­ties, flex­i­ble fund man­agers have an op­por­tu­nity to buy into those shares. Marais found that dur­ing mar­ket cor­rec­tions, flex­i­ble funds out­per­formed eq­uity funds, adding to their over­all out­per­for­mance.

Not all flex­i­ble funds are equal

While Marais makes a good ar­gu­ment for flex­i­ble funds, his re­search only fo­cuses on some of the bet­ter-per­form­ing funds that make up part of Glacier by San­lam’s “shop­ping list”, which is made avail­able to fi­nan­cial ad­vis­ers to help them se­lect funds for their clients.

Th­ese in­clude as­set man­agers PSG, Bateleur, Lau­rium and Truf­fle. But when you look at the uni­verse of 67 South African flex­i­ble funds, the re­turns are di­ver­gent. The fol­low­ing are based on re­turns up to De­cem­ber 31 2015:

Over a six-month pe­riod, the top-per­form­ing fund de­liv­ered a 15% re­turn, while the third-worst-per­form­ing fund de­liv­ered a neg­a­tive 8%*. The me­dian re­turn for the cat­e­gory was 1.82%.

Over a one-year pe­riod, the best-per­form­ing fund de­liv­ered 23% com­pared with a neg­a­tive 6.25% from the thirdbest-per­form­ing fund*. The me­dian re­turn was 6.34%.

Over a five-year pe­riod, the best fund de­liv­ered 20% a year, while the worst fund de­liv­ered a neg­a­tive 1.53% with a group me­dian re­turn of 9.66%. This means that, over five years, the best-per­form­ing fund de­liv­ered a to­tal re­turn of nearly 170%, while the worst-per­form­ing fund de­liv­ered a loss of 8%.

(*The Third Cir­cle fund re­turns were left out of the above ex­am­ples be­cause they are an anom­aly.)

Se­lect­ing the cor­rect fund is ex­tremely im­por­tant, and part of that se­lec­tion process is un­der­stand­ing how the un­der­ly­ing port­fo­lio is man­aged and un­der­stand­ing the risks that are be­ing taken by the fund man­ager be­cause flex­i­ble funds do not share the same risk pro­files.

A great ex­am­ple is as­set man­age­ment com­pany Third Cir­cle, whose tar­geted re­turn fund wiped out 66% of its clients’ money in two days in De­cem­ber, when the mar­ket plum­meted af­ter then fi­nance min­is­ter Nh­lanhla Nene was fired.

Af­ter an in­ves­ti­ga­tion by the man­age­ment com­pany, Met Col­lec­tive In­vest­ments CEO Mickey Gam­bale con­cluded that “the fund strat­egy em­ployed by the port­fo­lio man­ager was un­able to cope with the ex­treme mar­ket events at the time and, as a re­sult, the fund suf­fered losses due to the mar­ket move­ments. De­riv­a­tive in­stru­ments and hedg­ing tech­niques em­ployed by the man­ager were un­able to de­ploy and be­have as the port­fo­lio man­ager had ex­pected, re­sult­ing in the sig­nif­i­cant de­vi­a­tions noted.”

Where per­for­mance is com­ing from

Ba­si­cally, Third Cir­cle was us­ing a high-risk strat­egy where big losses could be in­curred. When se­lect­ing a flex­i­ble fund, do not just look at the re­turns – make sure you un­der­stand the risk pro­file of the fund you are in­vest­ing in by read­ing the fact sheets. Some funds will talk about a bal­ance between growth and pro­tect­ing in­vestor cap­i­tal, plac­ing their funds in the mod­er­ate risk cat­e­gory, while others will stip­u­late that they are tar­get­ing high growth and a higher-risk strat­egy.

Adri Messer­schmidt, se­nior pol­icy ad­viser at the As­so­ci­a­tion for Sav­ings and In­vest­ments SA, says that when it comes to flex­i­ble funds, you should ide­ally be get­ting ad­vice from a fi­nan­cial ad­viser who has knowl­edge of the fund and is able to make an in­formed de­ci­sion based on your re­quired risk and re­turn pro­file.

Messer­schmidt says there are many lay­ers of pro­tec­tion for a client to en­sure that a fund is man­aged within its port­fo­lio man­date. The fund man­ager has to pro­vide in­for­ma­tion to their com­pli­ance of­fi­cer, a com­pli­ance of­fi­cer at the prod­uct provider/man­age­ment com­pany, and the trustees of the fund.

The Fi­nan­cial Ser­vices Board also re­quires reg­u­lar in­for­ma­tion to en­sure that the fund is meet­ing reg­u­la­tions.

Flex­i­ble funds can, how­ever, take fairly ag­gres­sive po­si­tions and, although fund man­agers are re­quired to pro­vide min­i­mum dis­clo­sure doc­u­ments, in­clud­ing a fact sheet with their per­for­mance and port­fo­lio hold­ings ev­ery quar­ter, a lot can hap­pen in three months.

Con­sid­er­ing that Third Cir­cle de­scribed its tar­geted re­turn fund as a mod­er­ate- to high-risk fund of­fer­ing “sta­ble pos­i­tive re­turns” sug­gests that fund man­agers don’t al­ways stick to their orig­i­nal man­dates, so it helps to in­vest through large fi­nan­cial ad­vi­sory houses like Glacier by San­lam, which have the buy­ing power to de­mand more dis­clo­sure than the av­er­age re­tail client has ac­cess to.

At the mo­ment, Marais says some funds are show­ing strong short-term out­per­for­mance, but when you drill down to their un­der­ly­ing port­fo­lios, they have taken sig­nif­i­cant bets on re­sources.

They are fully in­vested in the mar­ket, with high ex­po­sures to sin­gle stocks such as An­glo Amer­i­can, which dou­bled in value between March and April this year.

One could ar­gue that there is a skill in iden­ti­fy­ing a strong rally in a sec­tor, but the counter-ar­gu­ment is that th­ese types of po­si­tions carry sig­nif­i­cant risks, which the in­vestor may not be aware of.

Past per­for­mance hides real per­for­mance

The other prob­lem is that short-term luck can also skew long-term per­for­mance sta­tis­tics. If a fund man­ager takes a re­ally big bet on a sec­tor and out­per­forms its peers by 15% over six months, even if the per­for­mance falls sharply af­ter that, their an­nu­alised re­turns would look im­pres­sive.

For ex­am­ple, if in one cal­en­dar year the fund de­liv­ered 15% in Fe­bru­ary but the to­tal re­turn from the rest of the year was just 10%, then its an­nual fig­ure would show 25%.

The fol­low­ing year, if the fund only av­er­aged a to­tal of 10% for the year, the two-year fig­ure would show an an­nu­alised re­turn of 16%. This hides the lack of con­sis­tency in its re­turn pro­file.

Marais says one should rather look at re­turns over a pe­riod of time on a monthly ba­sis. So, for in­stance, what was the one-year re­turn fig­ure at the end of Jan­uary 2015, the oneyear re­turn by Fe­bru­ary 29 2015, then the one-year re­turn by March 31.

“This is then plot­ted and one can clearly see how con­sis­tent th­ese one-year fig­ures are. The same ap­plies to three-year and five-year fig­ures. This tends to smooth the re­turns, with the ef­fect of big monthly re­turns a lot more muted.”

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