There are currently nearly 1 600 collective investment schemes registered in South Africa. In the multi-asset high-equity category alone, investors have almost 250 funds to pick from.
Given this level of choice, anyone who uses a financial advisor to make their investment decisions should want to know what criteria they are using. How do they decide which funds should go into their client portfolios?
“Clients should question the process their advisor follows in selecting funds,” says Shaheed Mohamed, product development manager at Allan Gray. “Just like asset managers are very different, so are advisors.”
Mohamed has compiled an analysis of the factors that local advisors consider when selecting unit trusts for their clients. Allan Gray surveyed more than 400 financial advisors across the country to gather his data.
Not surprisingly, past performance was the most important attribute advisors are looking for. As the table below shows, absolute performance came out as the most significant factor in decision making, followed by relative performance against similar funds, or a benchmark.
“Risk measures also relate to performance – they are generally a function of performance and how that performance was delivered,” Mohamed says. “So the top three are all directly or indirectly related to performance.”
Long-term versus short-term returns
Advisors reported placing the most emphasis on five-year returns, followed by returns over seven years. This encouragingly suggests that advisors are making decisions based on longer-term performance.
However this doesn’t match with data on fund flows, which rather appears to show that money is moving in and out of funds based on short-term results. The below graph showing net flows for the Allan Gray Stable Fund against its one-year performance bears this out, as money flows in when performance has been good and out when it falls:
“I expected performance to be the number one factor, but I didn’t expect advisors to place as much emphasis on longer-term performance given flows data,” says Mohamed. “It’s possible that advisors do have a preference for longer-term performance, but when they meet with clients there is pressure on them to switch. Investors can be more emotional when it comes to their money and advisors could capitulate under investor pressure because they fear losing them.”
Mohamed says that he found it interesting that responsible investing was the least important factor in the decision making of advisors.
“I think this is becoming more and more important, and especially in a global context money has been flowing to self-proclaimed responsible investing funds,” he says. “But its quite low down on the radar for advisors here. Maybe advisors rely on the asset managers to make the correct decisions, but I think there should be more emphasis on this because clients will question when things go wrong. We’ve seen it ourselves through certain holdings we’ve had in the past.”
He said this is an education gap that probably needs to be addressed.
“There might be a perception that if you are focusing purely on environmental, social and governance (ESG) factors you might impact returns, but the reality is if you invest in companies that don’t take the environment or society or governance into account, that can erode returns over the long term and destroy value for clients,” Mohamed says.
Tenure and qualifications
Interestingly Allan Gray released its research on the same day that Leigh Köhler, the head of research at Glacier by Sanlam put out a study on characteristics of fund managers in the South African multi-asset and general-equity categories. The research looked at the relationship between factors such as tenure and qualifications and fund performance.
Glacier found that managers with tenure of between 16 and 21 years produced the best five-year returns. This dominance was particularly notable in general equity funds, while managers with tenure of between 11 and 16 years performed better in the multi-asset high-equity and flexible fund categories.
This shows parallels with the Allan Gray analysis, which found that when looking at how long a fund manager has managed a fund, advisors prefer those with a tenure of longer than seven years.
Something that stood out in the Glacier analysis, however, was that although 49% of local fund managers are CFA charter holders, fund managers with a CFA significantly underperformed those without. They also delivered this underperformance at higher levels of risk.
Fund managers with an MBA qualification, however, produced much better returns at lower levels of risk than those without an MBA.
|Fund manager qualification and performance|
|Fund managers with an MBA||11.58%|
|Fund managers without an MBA||10.77%|
|Fund managers with a CFA||10.24%|
|Fund managers without a CFA||11.59%|
|Fund managers with a CA||11.68%|
|Fund managers without a CA||10.65%|
This is notable because Allan Gray’s analysis showed that the qualification most advisors looked for was a CFA. As the below graph shows, an MBA was considered even less important than a CA or generic post-graduate degree.