Weekend Argus (Saturday Edition)
‘Herd mentality’ exposes your equity funds to more risk
The market rewards different investment styles at different times. Ideally, your investments should be managed by a blend of managers who follow different styles, to reduce risk and enable your portfolio to out-perform the market throughout its cycles. La
Investment managers do not always stick to their stated investment philosophies, and there is evidence that many are managing money in similar ways.
This is according to the latest Alexander Forbes Manager Watch survey of retirement fund portfolios.
The survey notes with concern that this “herding”, particularly among managers of equity funds, means that many managers are vulnerable to similar market trends. Therefore, even if you, as an investor, have spread your investments across different managers, you could find your investments performing the same way when a trend, such as the commodity cycle, affects performance.
The survey reveals how managers of retirement fund portfolios have performed relative to their peers and their benchmarks. The analysis of their performance is relevant to anyone who is choosing more than one asset manager to manage their long-term investments.
The survey includes 46 investment managers and 335 retirement funds with assets under management of R4.94 trillion, and covers 14 different investment strategies.
The survey begins with a big warning that performance alone will not help you to identify a skilful manager.
Performance data contains too much “noise” – factors beyond a manager’s control that “contaminate” the data; so it can be dangerous to attribute good returns to skill, the survey says.
And instead of simply considering who is at the top of the performance tables, the survey says you should be concerned about whether you have a mix of managers that complement each other, rather than do the same thing.
Typically, the trustees of a retirement fund should determine what they need the fund’s investments to do to meet the fund’s liabilities. This is called the desired outcome, the survey says. You, as an individual investor, should determine your desired outcome.
Then your fund’s trustees, or you, should choose an appropriate asset allocation and set benchmarks against which the performance of the investments in each asset class can be measured.
The biggest allocation of a retirement fund, or a long-term investor, is likely to be to equities, because this asset class is most likely to produce inflation-beating returns. If you are investing for the long term, you need to accept the risk inherent in investing in equities. Investment managers follow many different investment philosophies, and the choice of philosophy is less important than the manager’s translating that philosophy into its portfolio construction, applying it consistently and understanding how it results in performance, Alexander Forbes says.
Trying to predict which manager will outperform in which period is a fruitless exercise, the Alexander Forbes Manager Watch survey says.
However, if you blend managers with different types of skill, you can reduce the uncertainty and maximise the periods over which your investments will generate outperformance, the survey says.
The challenge is that you need to blend styles that complement each other, rather than double up on the same style, and to do that, your retirement fund’s trustees, you or your financial adviser needs to identify managers that do what they profess to do when managing your money. In particular, the survey says you need to understand:
◆ How a manager’s investment philosophy and process (how it chooses shares) provide opportunities for it to identify and capture alpha;
◆ Whether a manager’s portfolios do, in fact, reflect its investment philosophy; and
◆ Whether the risks that a manager takes are adequately rewarded.
Your analysis should examine a manager and its portfolios over time.
The Alexander Forbes Manager Watch survey uses various measures to determine whether managers adhere to their philosophies, the risks they take, the timing
The survey says the simplest way to benefit from equity returns is to invest in a passive investment – in other words, a fund that tracks an index. In this way, you earn what is known as beta.
However, if you use an active fund manager, you can potentially improve your returns or reduce your investment risk, or preferably both, the survey says.
When a manager enhances the return you can earn from a market, it is said to generate alpha.
The Alexander Forbes Manager Watch survey says a manager has to invest differently from the benchmark to earn alpha. Although this has the potential to compromise beta, it should result in the manager earning a higher return than an indextracking investment.
Investment managers use different investment styles to generate alpha. Alexander Forbes says that different equity investment styles are rewarded over different periods, so a manager is likely to have periods when it either out-performs or under-performs the market.
A blend of different managers should reduce, rather than amplify, investment risk and ensure that your returns are consistently above the market throughout different market cycles, the survey says.
According to the survey, over the past few years, the value style has underperformed the market, while the momentum style has out- performed market indices (see “Definitions”, right).
Over the 2014 calendar year, the momentum, minimum volatility and quality styles were rewarded, while the value and deep value styles continued to struggle, the survey says.
Value, or valuation-based, and momentum are the most prevalent investment styles among South African fund managers, and the “herding” is particularly towards the value and contrarian styles, the survey says.
Alexander Forbes says the popularity of value and contrarian investing has resulted in many managers diving into resource shares and eschewing shares that have performed well, such as Naspers, Aspen and MTN.
The survey notes that, overall, equity managers failed to out- perform their benchmarks in 2014, despite the markets presenting opportunities for them to do so. In 2014, only 15 equity managers out of 50 (that each manage a group of similar portfolios) beat their benchmarks.
It says the under-performance of deepvalue managers is understandable, because this style has not been rewarded by the market for some time.
The survey says very few managers of benchmark-cognisant portfolios out-performed their benchmarks over the year to the end of 2014 (only two out of 19 managers of groups of similar portfolios), while only 11 out of 28 funds managed by benchmark- agnostic managers out- performed their benchmarks.
The survey notes that there was greater diversity of performance among benchmark-agnostic managers, and these managers have a better chance of protecting you from a downturn in the market than a manager that follows the benchmark closely and typically has more shares.
In comments on the performance of multi-asset portfolios that can invest offshore, the survey notes that most managers were defensively positioned, with too much invested in cash. This, together with their stock selection, impacted negatively on their performance.