CIARAN RYAN: Selecting to invest in the wrong fund at the wrong time is something that happens daily. Industry flows and years of research show that investors habitually chase performance and are notoriously bad at timing the markets which, often have severe consequences. Today, we speak to chief investment officer of PSG Wealth, Adriaan Pask about how investors can mitigate this risk. Hi Adriaan, this is normally called selection risk. What is that exactly? And take us through what this means and how it affects performance.
ADRIAAN PASK: Hi Ciaran, thank you very much for having me. So, what we see in the industry, there’s been quite a few new unit trusts made available. So, currently we are sitting at roughly 1 700 FSCA-approved unit trust funds in South Africa. And that’s roughly five times as many funds as what we do have stock listed in the JSE. So, investors have plenty of choice but obviously that also comes at the risk of choosing poorly, and that risk we define as selection risk. And we believe the risk is very high at the moment, not only because of the number of funds available, but also because the dispersion of returns, amongst this group of 1 700 funds, is at severely elevated levels.
CIARAN RYAN: Why do investors make this mistake? And this is a subject that is coming up year after year. We keep on reading about this in the press, investors keep on making the same mistake over and over.
ADRIAAN PASK: Yes, 100% agreed. I think , you know they say, luck is the intersection between opportunity and preparation. I’m wondering if it’s bad luck is then maybe partly due to poor preparation. I think that better be our point of view at PSG. So, the lack of a clearly defined plan sits at the heart of the problem. Because when you run into volatility in the market and you don’t have a clearly defined plan to guide you and give you some stability and some peace of mind, you end up making mistakes, you start chasing performance. And I think, as I said, this dispersion between the best and worst performing funds, is very high at the moment. And if you are going to do that and make mistakes, the cost is quite high to get this wrong.
CIARAN RYAN: Okay. You’ve raised something there, the dispersion between the best and the worst performing funds, please explain what that is and why this is important to pay attention to.
ADRIAAN PASK: Well, it’s actually quite simple. The gap in the returns between the worst performing funds and best performing funds, and what we saw, actually not too long ago, when equity returns were quite flat, we worked out a couple of conversions of returns around that 6% level. So, whether you’ve invested in a money market fund, or a fixed income portfolio, or a multi-asset portfolio, or an equity fund – all of these were more or less at that 6% level and that introduced a rather interesting thing from an invested layer perspective.
Investors then ask why am I taking on additional risk in multi-asset funds or equity funds if I’m going to end up with a similar return to a fixed income type of investment? So, this drove investors either into cash or into offshore portfolios.
And if we look at the Asisa [Association for Savings and Investment South Africa] numbers that were released for the end of March, the close for the 12 months amounted to R200 billion, which is great because obviously investors are investing in that, that’s what we want. But of this, 90% went into the fixed income pipelines. And with interest rates at such lows and equity markets on the bounce up and recovering, obviously that 90% could have been invested more optimally. So, that’s one part of it, and obviously that behaviour also accelerates the recent stock markets shock and the price volatility. So, there are more investors moving into that more conservative mandate.
CIARAN RYAN: So, what should investors be doing now? We’ve talked about the dispersion risk and the selection risk. How do they respond to that?
ADRIAAN PASK: Well, I can suggest three things.
The key thing is to have a clear plan and stick to it. You can’t invest on a whim, you’re a sitting duck for all the behavioural biases that you often read about and your chances of success are unbelievably poor. We can see that from the recent pattern of the industry plays, which I mentioned before.
A second thing to keep in mind is don’t pick an asset class. This is something that we’ve been seeing more lately in the industry, so as I said, investors like going either offshore or into cash. And that’s opened the door for investors looking at asset classes specifically and we actually think it’s a very good time to consider multi-asset funds which in recent years has fallen out of favour. But I would definitely recommend speaking to your wealth manager about that. Because, in this climate the value proposition is actually quite strong. You sit with a very well diversified portfolio across asset classes, and the nature of those mandates are quite flexible and active. So, those are two very valuable traits in a volatile market. So, the experts often actually navigate across asset classes and with this dispersion, between asset classes in cash going from round about that 4% level and equities doing 50% plus. But there are also risks.
And the offshore component is also something to keep in mind – that these funds that managed to do quite well, it’s vital still having a 30% odd investment offshore, but it has introduced a lot of diversification benefits in a period like last year when we saw the currency lose a lot of value. I think that value proposition is strong and it manages that dispersion. If you look at the one year running recurrence for example, that dispersion between the best and the worst performing funds, that was actually higher than 250% last year. If you’re on the wrong end of the range then the opportunity costs can be quite significant. But in a multi-asset portfolio you’ll at least be somewhere around the middle and reduce the risk of being [exposed to poor performance].
CIARAN RYAN: Okay Adriaan, we’re going to leave it there. That was chief investment officer of PSG wealth, Adriaan Pask talking about the impact of selection risk on your wealth creation plans.
Brought to you by PSG Wealth.
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