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Should you invest in poor performers?

Does the theory hold water that one year’s poor performers outshine the top performing funds the next year?

Including exchange traded products, there are currently 119 general equity funds registered in South Africa. Not one of them has delivered a negative return over the last 12 months.

However, some of them have still done a lot better than others. While the best return an investor could have received from a general equity fund over the last year is around 33%, the worst is just 2%.

As a private investor, what should one make of that discrepancy? Are the top funds going to be consistently good, or are the bottom ones more likely to take their place?

One theory that has been making the rounds is that investors are actually better off putting money into the poor performers. The thinking behind this is that the bottom funds of one year, will turn their fortunes around and become the top performers the next.

It sounds convenient, but is there any logic to it?

From the outset, there are three problems with this theory. The first, and most obvious, is how an investor should judge “a year”. Is it any rolling 12-month period, a calendar year, or is there some magical date on which the “unit trust year” ends and another begins?

For any of those to be valid, a very convincing argument would need to be presented as to why unit trust performance, or any investment performance for that matter, should be defined by any 12-month period. The ups and downs of the market are certainly not regular.

The second issue is that this theory ignores factors inherent in certain unit trusts that affect their performance. These are things such as each fund’s allowable asset allocation, it’s house view and, of course, the personality of the fund manager. Is he or she really better at picking stocks than a monkey with a pin?

Thirdly, this view suggests that all funds revert to the mean (and specifically do so over every two year period). It believes that the poor performing funds must get better, while the good performers must get worse. Sometimes this does happen. There are certainly examples of funds that set the world alight a few years ago that don’t look so clever now. There are also funds that were bottom-feeders quite recently and are now soaring like eagles.

But it is not true that all funds behave this way. Some star funds really do consistently out-shine their peers and some, sadly, are perennial skunks.

Below is a list of the ten top-performing general equity funds over the last year. The one year cash value represents what an investment of R100 made on the 1 September 2011 would have been worth at the end of August 2012.

Top ten

 

Fund

1YR Cash value

Mazi Capital Equity Fund

133.06

36ONE MET Equity Fund

132.17

Marriot Dividend Growth Fund – R

127.82

BoE Core Equity Fund

126.74

Foord Equity Fund

126.56

Stewart Macro Equity FoF – A

126.38

Momentum Best Blend Specialist Equity Fund – A

126.13

RMB Private Bank Equity Fund

125.45

Imara Equity Fund

125.45

Harvard House General Equity Fund

125.44

As at 31-08-2012

Source: MoneyMate

The first point to make is that eight of these funds are also in the top ten over the last three years. The Mazi Capital Equity Fund doesn’t make that list as it only launched in August 2010, while the Stewart Macro Equity FoF rates 16th over the last 36 months. This suggests that these funds are not going through good years and bad years, but maintaining a decent level of returns.

The 36ONE MET Equity Fund and BoE Core Equity Fund, for example, would have turned R100 invested on 1 September 2009 into R198.09 and R161.50 respectively. In both instances, this is substantially above the three-year sector average of R145.89.

It would also be difficult to argue that these performances are constituted of two good years and one bad year. For the 12 months to 31 August 2011, both of these funds delivered a return of over 17% – a better return that the FTSE/JSE All Share Index over the same period.

Bottom ten

 

Fund

1YR Cash value

Old Mutual High Yield Opportunity Fund

109.61

Flagship IP Equity Fund – A1

108.02

Verso Long Term SA Equity Fund

107.83

Element Earth Equity Fund – A

106.88

SymmETRY Satellite Equity Fund No.2

106.39

Personal Trust SA Equity Fund

105.88

Kagiso Islamic Equity Fund

105.34

Discovery Equity Fund

104.11

Coris Capital General Equity Fund

103.17

Element Islamic Equity Fund – A

101.96

As at 31-08-2012

Source: MoneyMate

While these ten funds have not performed as consistently as the top 10 have done, four of them – the Element Islamic Equity Fund, Coris Capital General Equity Fund, SymmETRY Satellite Equity Fund No.2 and Element Earth Equity Fund – do appear in the bottom ten performers over the last three years. These under performers would not even have made as much in the last three years as any of the top ten funds has returned in the last 12 months.

It is clear, therefore, that anyone who jumped into any of these funds two years ago because they were bottom of the pile then wouldn’t have made the smartest decision.

It is also noticeable that two of the unit trusts on this list are Islamic funds. These are Shariah compliant funds that do not invest in businesses considered unlawful or unjust under Islamic law. This excludes businesses such as banks that operate on interest payments, as well as companies involved in gambling, tobacco, alcohol, or many forms of Western entertainment or advertising considered against Islamic values.

In the limited South African environment, this can make such funds heavily reliant on resource stocks and this has hurt their performance. One indication of the difficulties in the resources sector is that not a single local resources equity unit trust has delivered a positive return over the last year. Another, is that 14 of the 20 worst performing shares on the JSE for the year to August 31 2012 are mining stocks.

This is the kind of structural quality that can severely impact on a fund’s performance. These Islamic funds are unlikely to turn the corner without a reversal in fortunes for resource stocks. Of course, it’s possible, maybe even probable, that this turnaround will happen. But to say when it will happen is to make a braver call than most people are willing to do, and certainly more than most are able to do with any accuracy.

The overall picture

According to MoneyMate, the sector average for all general equity funds to August 31 is R116.17. This is marginally below the performances of both the FTSE/JSE All Share index, which has gained 17.5% over the last year, and the FTSE/JSE Top 40, which is 16.3% higher.

If these indices are taken as benchmarks, only 47 of the 119 general equity funds (39.5%) have beaten the All Share, while 64 (53.8%) have done better than the Top 40.

Instead of gravitating to the bottom funds out of a belief that their turnaround is inevitable, a private investor might rather consider looking at these funds that have out-performed the market and investigating whether they have done so consistently. Not over one year, perhaps not even over three years, but over five or ten years. There funds that have shown that they have what it takes to give an investor solid returns over the long term and those are the ones that deserve attention.

Finally, it’s interesting to note how these funds rate against local exchange traded products. R100 invested in the Satrix Rafi a year ago would be worth R115.92, while the same amount invested in the Satrix Divi would have grown to R117.74.

For more, visit Moneyweb’s Click-a-unit trust/ETF and unit trust portfolio tools.

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