Aug 12, 2020
Generally, you should not alter your investment strategy or its execution unless it was incorrect at the outset, or your personal or financial circumstances have changed. At crucial points, such as when you get married, have children, get retrenched or retire, we strongly recommend that you consult a qualified financial advisor. Absent such change, the basic rule is: “Do not let shorter-term market fluctuations and negative market commentary sway your commitment to your long-term investment goals.” There is much research that supports the view that investor behaviour is a destroyer of investor returns,1 and that investors should “stay the course”.
Having said that, we believe that you should re-evaluate a fund in which you are invested if one of the following warning signals is triggered:
The portfolio manager is the key individual responsible for delivering on the fund’s stated investment objective. Prior to making your investment, you (together with your financial advisor) would have evaluated the portfolio manager’s ability to deliver on the fund’s mandate. A change in portfolio manager necessitates an evaluation of the new portfolio manager’s ability to continue to do so.
In most instances, a portfolio manager is supported by a team of investment analysts. It is likely that these analysts play a significant role in the fund meeting its investment objective over time. Therefore, changes to the analyst team also necessitate the re-evaluation of the fund.
When selecting a fund to assist you in meeting your long-term investment objectives, you may have done so based on the portfolio manager’s investment philosophy, for example value, growth or momentum-focused. It may be that after a period of underperformance because the investment style has been out of favour (value underperformance comes to mind over the past eight or so years), the portfolio manager starts to drift away from the stated investment philosophy. This style drift will likely result in the fund neither meeting its investment objective over time nor fulfilling the role for which you selected it. This should therefore trigger the re-evaluation of the fund.
A fund such as the Ninety One Diversified Income Fund aims to participate when the bond market outperforms cash and protect when the bond market underperforms cash. As illustrated in Figure 1, the fund has been able to consistently deliver on its cash plus objective over time. It is this sort of consistency through various market regimes that is important when considering which funds to include in your portfolio, as you need to be confident that the fund will continue to behave as you expect into the future.
Figure 1: Ninety One Diversified Income Fund: average rolling 12-month excess returns over cash
Source: Morningstar and Bloomberg. Returns are based on a lump sum investment, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested; fees are not applicable to market indices. Where funds have an international allocation this is subject to a dividend withholding tax, in South African rand. Data from 30.09.10 to 30.06.20. Highest and lowest returns are those achieved during any rolling 12 months over the period specified. Jul 12: 13.4% and Jan 14: 4.5%.
Change in the ownership structure, particularly where the asset manager has been acquired by a third party can be very distracting for all staff, including investment professionals, if not managed correctly. Portfolio managers and investment analysts are only human, and a change in ownership could result in an inward focus. Independent, focused asset managers with significant staff ownership are well aligned to delivering on client expectations through time.
While the fund selected may continue to meet its investment objective over time, it may be that a better alternative emerges. It is important then that financial advisors (and their support team/fund selection partner) continue to research the peer group. If an alternative fund consistently delivers better risk-adjusted returns, it may make sense to introduce this fund into your portfolio.
It is important to ensure that you are sufficiently rewarded over the long term for the fee that you pay. A lower fee may not necessarily be an indicator of a better net return outcome. On the other hand, a higher fee needs to be scrutinised to ensure that you get value for money.
When you made the initial investment, your analysis suggested that the portfolio manager had a demonstrable skill. But over time it now appears that, for whatever reason, this outperformance proved to be because of luck not skill. A re-evaluation is warranted given that luck is not enduring through time.
Significant cash flows in either direction over a short period of time may impact a portfolio manager’s ability to implement their investment philosophy. Monitoring cash flows is therefore important. In this regard, it is also important to understand how concentrated the “ownership” of the fund is, as a fund with a few large investors could be materially impacted should one or more decide to exit.
Certain investment philosophies’ ability to deliver outperformance reduces as assets under management grow and portfolios become unwieldy. It is crucial that the asset manager has the discipline to close to new investments and not succumb to greed.
With managers now able to invest up to 30% offshore and a further 10% in Africa ex-South Africa (in respect of Regulation 28-compliant funds and funds classified by ASISA as South African portfolios2), it is essential that the managers demonstrate excellent, fully integrated investment capabilities, with local and offshore assets managed holistically. While some managers may outsource the offshore holdings in their South African portfolio, we believe it vital they are managed with full oversight by the South African fund’s portfolio manager(s), rather than as a bolt-on portfolio of vanilla assets benchmarked to a global index. Bolt-on, at best, does not enhance the risk/return trade-off and at worst leads to unintended positions within the fund.
Over time, economies are expansionary and investment markets deliver positive returns, but both may become over-heated. At this point it may make sense to de-risk your portfolio by reducing exposure to high beta funds (funds that follow a momentum investment philosophy, for example) and introducing more defensively-positioned funds (for example, funds that follow a quality investment philosophy). Unfortunately, timing such a move is extremely difficult and therefore it makes sense to include a defensively managed fund to which you maintain exposure through the cycle.
While funds such as the Ninety One Cautious Managed, Opportunity or Global Franchise Funds meaningfully participate in strongly positive markets, they demonstrate the true strength of the Quality team’s approach in sideways-moving and negative markets. The result is that they outperform through the market cycle, as illustrated in Figure 2 of the Ninety One Opportunity Fund. This enduring performance signature has benefited long-term investors.
Figure 2: Ninety One Opportunity Fund – relative strength in sideways to down markets
Average rolling 12-month performance
Past performance is not a reliable indicator of future results, losses may be made.
Source: Morningstar, dates to 30 June 2020, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested; fees are not applicable to market indices. Where funds have an international allocation this is subject to a dividend withholding tax, in South African rand. Data since May 2000. Highest and lowest returns are those achieved during any rolling 12 months over the period specified. Jul 05: 43.8% and Feb 09: 15.7%.
While this list is not exhaustive, it provides some warning signals that should trigger the re-evaluation of your current fund holdings. Importantly, any change should be carefully considered in the context of your overall investment objectives and any potential capital gains tax consequences. Again, we would recommend that you consult with a qualified financial advisor.
1 Dalbar’s Quantitative Analysis of Investor Behaviour Study has been analysing investor returns since 1994 and has consistently found that the average investor earns much less than what market indices would suggest.
2 ASISA Standard on Fund Classification for South African Regulated Collective Investment Scheme Portfolios, 30.10.18.
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