Are you joining the income fund herd?
It is well known that humans are generally at their most intelligent and rational when they are alone or in small groups. As the size of the group grows, so the rationality and intelligence of the group falls. That is why crowds can become mobs.
One of the biggest crowds in the world is the investment market. Millions of people make decisions daily on money, and very often they start to do things collectively and act in a very irrational way.
Investment professionals and academics have unkindly described this irrational behaviour as “herding”. We now see a live example of investors acting as a herd in the SA unit trust market.
Morningstar recently published a report that monitors flow of money into different types of unit trusts, and the results should worry investors.
In the past three months, the only SA unit trusts attracting money were those that pay interest to investors, namely money market and income funds. There have been large outflows from unit trusts that invest in shares, including lowrisk and balanced funds.
The question is: why are you, as an investor, buying money market funds now?
I suspect there are two main reasons: bad advice from advisers and investors chasing past performance.
It is a sad reality that the average money market unit trust delivered 7.5% a year for five years while the average equity unit trust grew only 2.4% a year in that period. It would have been a great idea to buy money market unit trusts five years ago! To invest in money market funds now, when they are already the top performer, is classic herding behaviour.
Investors (and bad advisers) who are now selling out of equity unit trusts and investing in cash are selling at the worst possible time. It is extremely rare for cash to beat shares over a five-year period. Whenever this has happened in the past, shares delivered very good returns for the next five years.
It is human nature to avoid losing money, so it is natural to want to sell your low-growth investment in favour of something that will deliver more stable and certain returns.
However, if you were invested in equity funds over the past five years, you will not be able to participate in the recovery of these funds if you decide to sell now. You also cannot “wait for things to get better” before you decide to reinvest in shares again. By the time “things are better” the stock market will have jumped up and you will not get much growth on your money.
I hear many people saying they don’t want to invest in the local stock market because SA’s economy is in bad shape and the stock market cannot perform if the economy is stagnant. This may seem logical, but it is not correct.
The SA stock market is driven largely by international companies that happen to be listed on the JSE for historical reasons. When we consider some of the largest companies on the JSE, we realise they have very little to do with the local economy. For example, Prosus is a global tech business. British American Tobacco is a global tobacco business and Richemont sells luxury goods around the world. If we consider resources companies like Anglo American and BHP, they have much more of their businesses outside the country than inside. So, if you are selling out of the JSE because of the state of the economy, you are making a mistake.
It is also reality that most unit trusts in SA are sold to investors by financial advisers. If you are an investor with an equity unit trust and you are unhappy with the performance, be very careful of the recommendations by your advisers if they suggest a change now.
If your adviser recommends selling shares or equity unit trusts in favour of a money market fund, I would personally seriously consider firing that adviser! It is your adviser’s job to have difficult conversations with you and to convince you to remain invested in poorperforming investments if there are good reasons for the bad performance.
Historically, poor-quality financial advisers are scared of giving their clients bad news and so they pacify them by recommending a switch into something that has recently delivered good returns.
Any rational person would be unhappy with the state of the SA economy and the terrible returns of the stock market. But rational investors would be considering the value offered by the JSE and whether it is a good time to buy. If you own equity unit trusts, should you really be selling now?