The unit trust industry has been lamenting the fact that investors have missed out on the best bull run we have seen in decades. Conservative investors who were badly burnt at the end of the Nineties have shown an unwillingness to enter the market. Investors have learnt that what goes up can also come down.
Risk profiling will tell you that if you are investing for your retirement in 25 years’ time, you should be fully in equities as you can withstand the short-term market volatility. But realistically, no one likes to see 20% of the value of their investment disappearing overnight even if they know they have another 10 years to recover.
Peter Brooke, fund manager at Old Mutual Investment Group (OMIGSA), argues that flexible funds offer the best solution. These funds have a mandate that allows them to allocate to various asset classes as they see fit. So a fund can be invested as high as 95% during a market boom, but can also reduce its equity exposure when concerns are growing. Brooke says this makes flexible funds a better structure than a pure general equity fund.
Retail investors have proven that, traditionally they are very poor at market timing and should leave it to the fund managers. Individuals would also incur capital gains tax and switching fees if they were moving in and out of the market. All of which is avoided by remaining within the structure of a unit trust fund.
Flexible funds can’t guarantee that you won’t feel pain when the market falls as they tend to be equity focused, but you will probably feel less pain and be protected from the worst of the market crashes while still participating in bull runs.
For example, Brooke says when listed property collapsed in June last year, it was a clear signal that it was over-sold. OMIGSA increased its property exposure in the Old Mutual Flexible Fund. Property subsequently grew by 28%, outperforming equities.
While a year ago the fund had 95% in equities in the belief that some strong growth was to come out the market, the team has cut that back to about 90%, moving some into property and increasing their offshore exposure.
The fund was holding 10% cash earlier in the year which, as Brooke admits, was an expensive move in a bull market, but it gave OMIGSA some flexibility when market volatility increased in February.
As the market ran strongly, up 5% in February, Brooke says OMIGSA felt that, in the short run, the market was a bit hot while still looking positive over the medium term. Therefore, rather than selling equities, OMIGSA took some derivative cover by hedging about 10% of the fund. It was a good move, as the market fell and OMIGSA made money from the hedge. The market correction created a buying opportunity and the team used some of the cash to buy more equities, reducing their cash levels to 7%. “We still see it as a bull market, but we are not as aggressively positioned as a year ago,” says Brooke.
While there is a general classification for flexible funds, it is important to understand the mandate of the fund manager and whether the fund is an asset allocation fund or not. An active flexible fund can take big bets against the balanced fund index, for example; it can hold no bonds if it is not offering value. However, the fund will always hold some level of equities as the aim is to deliver superior growth over time.
While professional investors are likely to get it right more frequently than retail investors, some funds have not performed well by calling the market wrong.
Some funds have been very bearish on the market and having a bearish view in a bull market and low equity weighting can cost you 15% against your peers, which is an expensive mistake.