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SA’s least volatile equity unit trusts

Looking for the best risk-adjusted return.

CAPE TOWN – In many parts of the world low volatility investment strategies are coming into vogue. These approaches were first captured by exchange-traded funds (ETFs), which are now some of the most popular products in markets like the US.

South Africa also recently joined this trend with the launch last month of Grindrod’s LowVolTrax ETF. The fund tracks the S&P Low Volatility Index, which tracks a basket of the 40 least volatile stocks on the JSE.

The appeal of these funds is inspired to some extent by the extreme ups and downs we have seen in equity markets in the last 15 years. Since the turn of the century, world markets have suffered two major pull-backs, and the idea of reducing volatility seems to have found favour with investors who were hit by these steep falls in stock prices.

The idea of low volatility funds is simply to offer a smoother investment journey by mitigating against extreme market movements. This means selecting assets or securities that display the lowest standard deviation, which removes some of the short-term downside risk.

It is important to bear in mind, however, that volatility works both ways – to the downside and the upside. So following a low volatility strategy may mean that returns are not as high in a bull market.

If one looked at this from the point of view of equities, the less volatile stocks are often defensive counters in sectors like healthcare or tobacco. These are sectors that perform through the cycle, since the services or products they offer are in demand regardless of the economic environment. That means that they should deliver better returns than the overall during bear markets, but probably won’t gain as much during bull markets when other cyclical stocks are running.

Risk-adjusted return

The Grindrod ETF is currently the only equity fund in South Africa that sells itself specifically on its low volatility approach. There are no active managers that have a primary mandate to capture low volatility in a pure equity fund.

However, even though local fund managers may not explicitly follow a low volatility strategy, it is still a very revealing exercise to analyse how funds compare in terms of their standard deviation figures. This is because a manager who is able to produce the highest return with the lowest volatility is giving investors the best “risk-adjusted return”.

A way to measure this was captured by William Sharpe in 1966. Sharpe, who went on to win the Nobel Prize in 1990, came up with the Sharpe ratio to show whether returns were earned through taking on more risk or through astute management.

Essentially, the ratio measures how much excess return an asset or portfolio is earning for the extra volatility is shows. A higher number shows a better performance.

This is important because it is one way of measuring the fund manager’s skill. If a manager is able to earn a high return without taking on higher risk assets it shows that he or she is skilled at picking the right securities at the right price to deliver sustainable performance.

The three tables below using figures from Morningstar illustrate this in the South African context.

Firstly, we rate general equity funds purely on their performance over the last three years. We then rate them based on their volatility. And finally we highlight those funds with the highest sharpe ratios.

South Africa equity general fund performance to 30 April 2014

Fund

3-yr annualised return

TER

Foord Equity Fund

23.48%

1.86%

Mazi Capital MET Equity Fund

22.72%

0.98%

Harvard House MET Equity Fund

22.40%

1.47%

PSG Equity Fund

22.33%

1.76%

Sasfin MET Equity Fund

21.55%

1.54%

Coronation Equity Fund

20.73%

1.15%

Imara MET Equity Fund

20.60%

1.73%

Stanlib Equity Fund

20.45%

1.25%

Coronation Top 20 Fund

20.19%

1.85%

SIM Top Choice Equity Fund

20.19%

1.99%

Sector Average

15.42%

 

FTSE/JSE All Share Index

17.78%

 

Source: Morningstar

These are the top 10 performing equity funds in South Africa on a pure return basis. As one would expect, they all performed well above the All Share.

It is interesting to compare that list to the below list, which shows the 10 least volatile funds over the same period.

South Africa equity general funds volatility to 30 April 2014

South Africa equity general funds volatility to 30 April 2014

Fund

3-yr standard deviation

3-yr annualised return

TER

Personal Trust High Yield Growth Fund

6.74

14.44%

1.38%

Aylett Equity Prescient Fund

8.13

17.76%

1.77%

Prime General Equity Fund

8.23

14.08%

1.06%

Nedgroup Investments Growth Fund

8.40

14.69%

1.72%

Ashburton Multi-Manager Equity Fund

8.53

19.12%

1.56%

IP Equity Fund

8.64

12.51%

1.63%

Mazi Capital MET Equity Fund

8.64

22.72%

0.98%

Old Mutual Albaraka Equity Fund

8.66

17.23%

1.72%

Verso MET SA Equity Fund

8.79

9.16%

1.47%

Sasfin MET Equity Fund

8.94

21.55%

1.54%

Sector average

9.31

15.42%

 

FTSE/JSE All Share Index

11.71

17.78%

 

Source: Morningstar

Immediately three things are obvious: firstly, that only two funds – the Mazi Capital MET Equity Fund and the Sasfin MET Equity Fund – make it onto both lists.

The second thing that stands out is that low volatility is not, on its own, a very good measure of active management. Only three of the funds on this list out-performed the All Share Index during the period under review.

The Aylett Equity Prescient Fund and Old Mutual Albaraka Equity Fund performed more or less in line with the All Share, but the others performed quite poorly. Consider that over the same period 30 multi-asset high equity funds returned better than 15.0% per annum, so pure equity funds that delivered returns lower than that can’t be said to have done very well.

And, thirdly, it is worthwhile to note that the average volatility of a equity unit trust is well below the volatility displayed by the All Share index. In fact, only six unit trusts displayed a higher standard deviation than the All Share over this period, and three of them are index trackers. So it is fair to say that, in general, active management is a less volatile investment.

In the final table, returns and volatility are brought together through ranking funds on their Sharpe ratio.

South Africa equity general funds Sharpe ratio to 30 April 2014

Fund

Sharpe ratio

3-yr standard deviation

3-yr annualised return

TER

Mazi Capital MET Equity Fund

1.89

8.64

22.72%

0.98%

PSG Equity Fund

1.73

9.27

22.33%

1.76%

Sasfin MET Equity Fund

1.71

8.94

21.55%

1.54%

Foord Equity Fund

1.68

10.19

23.48%

1.86%

Harvard House MET Equity Fund

1.67

9.60

22.40%

1.47%

Imara MET Equity Fund

1.55

9.27

20.60%

1.73%

Ashburton Multi-Manager Equity Fund

1.52

8.53

19.12%

1.56%

Stewart Macro MET Equity FoF

1.51

9.19

20.08%

2.49%

Stanlib Equity Fund

1.49

9.52

20.45%

1.25%

Aylett Equity Prescient Fund

1.44

8.13

17.76%

1.77%

Apart from the Stewart Maco MET Equity FoF, all ten of these funds appeared on at least one of the first two lists. The Mazi Capital MET Equity Fund is the obvious stand-out.

The top nine of these funds all performed better than the All Share index and with lower volatility. The Aylett Equity Prescient Fund delivered a return in line with the All Share, but with a significantly lower standard deviation.

Some would argue that these were really South Africa’s ten best-managed equity unit trusts over the last three years, and not the ten that appear on the first list that ranks them only by performance. By generating strong returns without attracting high levels of volatility, these fund managers have ultimately given investors the best balance between risk and reward.

For more, visit Moneyweb’s Click-a-unit trust/ETF tool.

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