Long and wind­ing or straight and safe?

All roads even­tu­ally lead to Rome, but it’s im­por­tant for in­vestors to de­cide whether they pre­fer a riskier or safer route to reach­ing their in­vest­ment goals.

Finweek English Edition - - MARKETPLACE - Edi­to­rial@fin­week.co.za Schalk Louw is a port­fo­lio man­ager at PSG Wealth.

ac­cord­ingto sci­en­tists, it is a fact that no two snowflakes look alike. Of course, we can also ap­ply this find­ing to peo­ple in that no two peo­ple are alike.

We re­cently took a fam­ily road trip through the Lit­tle Ka­roo. Aside from be­ing one of the most beau­ti­ful places on earth, it is also well-known for some of the world’s most breath­tak­ing moun­tain ranges. We spent the night in Prince Al­bert with Oudt­shoorn as our next desti­na­tion. We had a choice be­tween two routes to get there: a longer but faster route via Meir­ingspoort, or a shorter but slower route over the Swart­berg Pass. De­spite my wife’s fear of heights, our daugh­ters con­vinced us to take the Swart­berg Pass. I’m not go­ing to dis­cuss in de­tail the amaz­ing scenery and tech­ni­cal driv­ing skills needed, but I did re­alise that although we reached our desti­na­tion safely, some found the jour­ney mind­blow­ing and fun, while oth­ers were ex­tremely fright­ened by it.

These emo­tions do not only ap­ply to peo­ple who climb moun­tains or jump from aero­planes, it also ap­plies to in­di­vid­u­als who face the task of de­cid­ing which in­vest­ment to choose. Let’s take two dif­fer­ent eq­uity fund man­agers: The first (Fund A, see graph) doesn’t care about the per­for­mance of other shares. They have a spe­cific strat­egy, they stick to it and they believe that they will get in­vestors to their in­vest­ment desti­na­tions safely.

For the sec­ond fund man­ager (Fund B), it is im­por­tant to re­main within the con­fines of some­thing like the FTSE/ JSE All Share In­dex and they cor­re­late their re­turns much closer to the re­turns de­liv­ered by the in­dex it­self. Both these funds hap­pen to be Gen­eral Eq­uity Unit Trusts, both have a fund value of at least R5bn, and more im­por­tantly, both man­aged to out­per­form the FTSE/JSE All Share In­dex on a to­tal pro­ceeds ba­sis over the last 10 years – an achieve­ment that only 29% of funds with a 10-year his­tory in this sec­tor can boast with. The dif­fer­ence be­tween these two funds, how­ever, is that Fund A not only un­der­per­formed at times when com­pared to the in­dex, but it even de­liv­ered ex­cep­tion­ally neg­a­tive re­turns while the in­dex per­formed pos­i­tively. Does this make Fund A the wrong choice, or a worse choice than Fund B? Not at all. All it shows us is that although both fund man­agers are clearly very skilled, as in the case with the Swart­berg Pass and my wife’s fear of heights, some in­vestors sim­ply won’t be able to tol­er­ate the risks as well as oth­ers.

The bet­ter ques­tion is how I can best pre­pare my­self be­fore choos­ing a spe­cific in­vest­ment. Do I choose the riskier in­vest­ment route that leads over the Swart­berg Pass, or do I choose the straighter, safer op­tion in a sit­u­a­tion where both funds of­fer a very im­pres­sive profit track record?

For me, the an­swer lies in the track­ing er­ror. The fi­nan­cial term for this ra­tio is de­fined as: “the di­ver­gence be­tween the price be­hav­iour of a po­si­tion or a port­fo­lio and the price be­hav­iour of a bench­mark” (Source: In­vesto­pe­dia). This de­vi­a­tion is usu­ally ex­pressed as a percentage. Based on his­tor­i­cal data, the higher the percentage, the higher the vari­ance in re­la­tion to the rel­e­vant bench­mark may be. Let’s again take the lo­cal Gen­eral Eq­uity Unit Trusts as an ex­am­ple: these funds’ two-year av­er­age track­ing er­ror cur­rently stands at 6.5%, which means that these funds can ei­ther out­per­form or un­der­per­form com­pared to the FTSE/JSE All Share In­dex over any 12-month pe­riod.

If large un­der­per­for­mances com­pared to some­thing like the FTSE/JSE All Share In­dex leave you feel­ing un­com­fort­able, rather choose funds or in­vest­ments with the help of a skilled quan­ti­ta­tive and qual­i­ta­tive re­searcher with a ra­tio of 5% or lower. For those who are less con­cerned with the re­turns de­liv­ered by an in­dex and who pre­fer to buy into the man­age­ment of the fund, Fund B’s track­ing er­ror of nearly 19% won’t mat­ter.

Although all roads lead to Rome in the sense that in­vestors would all gen­er­ally like to reach the same in­vest­ment goals, it is ex­tremely im­por­tant to de­cide on the route you need to take to reach your goals, so that you can pre­pare your­self for the jour­ney to the best of your abil­i­ties.

Do I choose the riskier in­vest­ment route that leads over the Swart­berg Pass, or do I choose the straighter, safer op­tion in a sit­u­a­tion where both funds of­fer a very im­pres­sive profit track record?

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.