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Chasing the winner

The problem with investing in top performers.

JOHANNESBURG – Every year news media publish a plethora of articles looking at the top performing shares and unit trust funds of the previous year.

For those investors that were lucky enough to have included these investments in their portfolios prior to the surge, the benefits can be significant. But often those who didn’t invest find themselves wondering: Should I invest in these shares or unit trusts now?

The table below shows the share price performance of the top performing shares in the local market over the past few years and their performance in the subsequent year.

 Source: JSE (Performance only refers to share price performance.)

While these limited examples suggest that investors may still have experienced some upside if they chose to invest in the previous year’s winner, this “strategy” also proved to be problematic in some instances.

Of course a handful of examples is not significant.

Do South African investors often invest in the top performing shares or unit trusts of the previous year?

Zwelakhe Mnguni, chief investment officer at Benguela Global Fund Managers, says it depends on the type of investor.

Given the significant scrutiny of their decisions by asset owners, professional investors tend to pour huge resources into company financial and operational analysis to derive reasonable estimates of true value, he says.

Mnguni says it is generally unheard of that professional investors have invested money in a business just because the share price did well previously.

“In fact, if anything, a substantial rise in the share price over a short period like a year, could make professional investors a bit more circumspect, around the prospects of such a stock.”

Mnguni says in contrast retail investors tend to have limited resources and information to make well-considered investment decisions. It is these types of investors who are prone to chasing winners as they speculate on persistence of such performance.

Patrick Mathidi, head of core strategies at Momentum Asset Management, says generally, and as evidenced by unit trust industry flow data, the retail investor does tend to invest in an asset class with recent performance in mind.

In other words, the best-performing asset class tends to attract the most flows, he says.

It is a bit “tricky” to make the same assertion for shares due to lack of granularity of flow information, Mathidi says.

But is it ever a good idea to invest in the top performing shares or unit trusts of the previous year?

Mnguni says it is a very risky and even reckless investment strategy to chase last year’s winners without thorough fundamental work.

To make an investment decision to either buy or sell a stock an investor needs a reasonable estimate of intrinsic value, as in the long term stocks tend to drift closer to their true worth, he says.

“It may be a regrettable mistake to buy purely on the basis of recent price movements. The fact that in the above examples Eureka and Bonatla were suspended a few months after showing phenomenal share price appreciation serves as a warning to the ‘chase the winner crowd’,” he says.

At a unit trust level, one equally needs methodical analysis of the investment process behind the performance, Mnguni says.

Mathidi says just like everything else worth buying, one needs to understand what one is buying, why the performance has been as strong and assess the likelihood of that performance being repeated.

He says one should also have some sense of value, in other words, what the value of the share is (as opposed to just the price).

Mnguni says in very rare instances, investors that dig deeper than an average investor may find opportunities where there is still exploitable undervaluation in the price, despite material recent price appreciation.

“Aspen and Naspers are good examples of stocks that have been in the top quartile of market performance over a number of years. Even in their case, there are often a few months of poor share price performance,” he says.

Mnguni says only if detailed research has shown that a stock is fundamentally undervalued may an investor allocate capital to it.

However the gap between true worth and share price may, sometimes, take a number of years to close so investors need to be cautious not to “bet the farm” on a single stock, he says.

Mathidi says it is important to remember that past performance is no indication of future prospects.

When after careful consideration and analysis investors do decide to invest in the top performing shares or unit trusts of the previous year, they should consider their investment objectives, investment timeframe and to what extent those considerations align with the share’s future prospects, growth and returns, he says.

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