Whether you decide to go it alone or with a financial expert, familiarise yourself with different fund options, writes Marize Pieters, investment analyst at Glacier
Some people like the excitement of the stock market and trade shares through a stockbroking account. This type of investor is solely responsible for the stock selection of his or her portfolio. Though some people successfully manage their own stock portfolios, this is often not the case for many people. It is an extremely risky and time-consuming affair complicated by issues such as capital gains tax.
If you do not like the kind of pressure associated with stock selection, a popular alternative is to invest in unit trust funds. The cheapest option is investing in a tracker fund that tracks an index such as the Alsi40. This is also known as a passive investment and should deliver market-related returns.
But, because of ongoing fees (albeit very low) your investment will not beat the market. In addition, there are a few disadvantages to passive investing that you should be aware of. As an investor you are directly exposed to the emotions and irrationality of the market, which can introduce substantial risk to a fund as was clearly demonstrated in the recent market downturn.
Because of South Africa’s rich mining background it should certainly not come as a surprise that half of the index consists of one sector alone, namely resources. Not only is the index biased towards resources, it is also extremely concentrated as the top 40 shares make up close to 80% of the index. These factors can add unwanted risk to your investment.
The other alternative is active investing. If you are willing to pay a fund manager an appropriate fee, he or she will actively manage the fund for you, thereby increasing your chances to outperform the market.
Although there are many advantages to active investing, a big disadvantage is the endless list of options available (about 900 unit trust funds) and the list continues to grow. The variety of funds can suit almost any client’s needs.
The crux here is how you make sure you choose the best fund to meet your financial needs with all the additional information in the market.
It is definitely not a game of luck any more and many investors have paid a high price for making uninformed decisions. When you take into account that investment professionals have a local stock market consisting of less than 300 stocks in which to invest, the average person on the street may be immobilised and disheartened by the number of unit trusts out there and may decide not to invest at all.
Is it possible that the unit trust industry has become the victim of its own success? Not necessarily. However, the industry has changed substantially in the past few years and there are new measures you should take into account when making an investment decision.
Choosing your investment
So how do you choose a good investment when there are so many options available? When choosing a unit trust fund, there is much more to consider than what meets the eye. If you are not an investment expert, seek the advice of a qualified financial intermediary who takes the following into consideration when selecting funds in line with your financial needs and risk profile.
The first rule of thumb is to compare apples with apples. Compare funds against one another that fall within the same ASISA category (Association for Savings and Investment South Africa) and risk profile within that category, if relevant.
Second, do some number crunching by using various quantitative measures when comparing funds. Cumulative performance is the most popular measure and is the return quoted on every fund fact sheet freely available on the web.
Rolling returns should be used in conjunction with this measure. It removes end-point bias and enables you to get a better understanding of a fund’s under- and overperformance over any period of time. Hence it is a useful method to examine the behaviour of returns for holding periods similar to those you would have experienced were you actually invested in the fund.
It is a good way of judging the degree to which a fund manager has been able to add consistent value.
Risk, often referred to as volatility, is also an important consideration. Choose a fund that is able to protect capital on the downside rather than one with massive swings in performance. The latter increases the volatility of the fund in the short term.
Third, past performance is not necessarily an indication of future performance and it is therefore essential that you combine your quantitative work with some qualitative analysis.
When investing in a fund you are essentially picking a fund manager. You need to be sure that the manager will stick to the investment philosophy and process that delivered the fund’s past performance.
Make sure the fund is managed according to its stated objectives. A low-risk fund should have a high focus on protecting capital in the shorter term.
Familiarise yourself with the qualifications and experience of the manager and his team. Find out what other responsibilities the manager has and if this will affect his ability to run the fund. You should guard against funds with excessive fees and if a performance fee is charged ensure it is reasonable.
There has been a lot of negativity surrounding performance fees, but, if the fee is fairly charged it can be an advantage as it aligns managers’ interests with those of their clients. Find out if a succession plan is in place to reduce the risk of high staff turnover within the team. These are just some of the pointers to consider when conducting your qualitative analysis.
A fund that scores highly both quantitatively and qualitatively should be a consistent good performer over time.
Remember to monitor your fund regularly. Continue to understand your managers’ latest views and why the fund is performing the way it does.
Have realistic expectations and stick to your investment horizon. Don’t let your emotions get the better of you in uncertain times. Trust your financial intermediary and fund manager and let them do what they do best - letting your money work for you.