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How does your advisor pick funds?

When there is so much choice.

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.

Source: Allan Gray

“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:

Source: Allan Gray

“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.”

Responsible investing

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
  5-year return
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%

Source: Glacier

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.

Source: Allan Gray

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COMMENTS   18

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i’ll say what I have said before – there are only TWO shares worth having on the jse – naspers and remgro. altho’ I must admit that the discount between naspers and tencent is getting worrying!

Advisor selects funds according to maximum commission. In the past they were known as insurance salesmen.

Dear Palaboran,

In another time and place your comments might have been applicable. Today all commissions/fees are very transparent and negotiated with the client upfront. There is no one fund that pays a higher commission than another.
Your comments perhaps relate to insurance based investment products which use unit trusts as their underlying investment vehicle. Two companies in particular–Liberty and Discovery are very good at hiding these fees.

They do exactly that, and then give themselves the maximum 1% allowed advice fee…

While that may be true for “tied” advisors (typically working for insurance companies or banks), for most independent advisors I would suggest that the same fees are earned irrespective of the funds selected.

From my experience they do it in 2 ways:
– by Most Commission
– or 10% each in the 10 funds I know

The fund manager has to choose between about 100 liquid companies on the JSE. The decision for the retail investor is much more complicated because there are 10 times more unit trusts to choose from. The party who needs a sophisticated process to identify his investments is the retail investor. What this comes down to is that the retail investor should be remunerated for investing in his fund by the unit trust manager. The fund manger merely passes his decision making duties (what he gets paid for) on to the retail investor.

This is a very useful article to bring to light how the industry has changed over the last 10 years and how it needs to change over the next 10 years.
Salesmen who were linked to life companies where incentivised to sell “products” which often locked the client in over a period of time and with high upfront fees to the adviser. One would hope that this changes under RDR going forward. Let one thing be absolutely clear, the life companies also need to take responsibility for creating these products that incentivised the advisers to sell them over and above vanilla unit trusts that are less exciting. There are still a number of life companies that are offering these “products”.

Advisers need to find their value add to clients which includes building a tailored portfolio to meet the needs, objectives and risk profile of the client. An adviser should use processes such as the creation of a short list of approved funds that was derived at through independent research. This ensures that the pool of funds that the adviser has to create a portfolio have ticked all the boxes. This quickly take 1600 funds to 50 funds or less. Unfortunately the idea of a short list has not been utilized on a mass scale yet.

The funds offered on the Allan Gray platform have FundHouse ratings to help the advisors make a more informed decision with regards to fund selection. Allan Gray also takes a stance to only including funds on their platform that have a positive rating by FundHouse and therefore help to mitigate the risk of having too many bad to average funds to choose from.

Allan Gray should be commended on their efforts to help evolve the industry into a more professional body of trusted advisers.

yes there are good investment houses ( Coronation, Foord, Allan Gray, to name a few).
To have a tool to help in short listing is very good.

However what is shining in it’s absence is the fact that I do not know of advisors that also recommend / choose ETF’s for their clients. As far as I know ETF’s don’t pay commission. In the past I’ve spoken to a number of advisors and policy hawkers. None of them mentioned ETF’s unless I asked about it.

Am I correct or did things change in the meantime?

Hi logically speaking

The topic of ETF/passive funds is a complicated one that is not to be taken lightly. From a fee perspective I’m not sure how they would work in remunerating the adviser. If one where to take a specialist building block approach to building an overall portfolio then the inclusion of ETF funds may be warranted to differing degrees during different parts of the market cycle. The problem is that if advisors where to take the “expert” approach to including a European ETF, South African small/mid cap ETF, global value ETF and unit trust funds then the adviser is essentially taking the roll of a fund manager by making specialist calls that are coming from a position of someone who lacks the equivalent skills and resources to make those calls.

This brings up the idea of a fund of funds approach or model portfolio where a skilled team of financial analysts are able to make those calls and use both ETF, passive and unit trust funds to build a low cost fund that incorporates specialist building blocks and funds into one offering.

Financial advisers should not be seen as specialist fund gurus who use building blocks to create their own portfolio. Inevitably over the long term a financial adviser’s guru “ideal specialist portfolio” will underperform the likes of Allan Gray, Coronation, Foord, Prudential etc. Instead I would hope to see fund of fund managers including ETF and passive funds where and when appropriate to enhance their fund and lower fees. This will create the environment where advisers have options to use best blend funds as well as blend multi-asset funds such as those offered by the managers named above.

From a fee perspective I would expect that fund management fees will start to fall gradually as the competition start to lower their fees. ETF and passive funds have definitely caused the industry to look at their fees.

The idea of reasonable fund performance fees also appeal to me. Managers should get a basic fee that enables them to be modestly profitable during market corrections (when one would expect them to loose asset under management) while the majority of their fees over the long term should be derived at through good performance. A flat fee of 1% to a manager regardless of performance as well as a performance fee when markets are performing well is not in the best interest of the investor and one could argue that going forward that business model may not be sustainable in the changing environment.

My last advisor didn’t “pick” funds.

He was affiliated with PSG and was “advised” by PSG what funds to put clients into.

Needless to say that it was a PSG fund of funds which in the past 3 years has earned me an incredible return of -8%

By throwing darts at a spinning dartboard whilst half drunk and blindfolded, standing with one leg on a balance board??

You didn’t mention that the dart thrower is a monkey.
Oops, one can’t say that sort of thing any more…

I just love that, according to the table by Glacier, fund managers without a CFA do better than fund managers with a CFA. Confirms what’s often been suspected.

Ask your adviser for a copy of their investment policy and what research has gone into that policy.

Besides having an investment policy, you should have one you can stick with.

Far too many advisers simply FICA their client – Foord, Investec, Coronation & Allan Gray – for all their clients, irrespective of needs, objectives or risk profile.

Some go the route of an active discretionary relationship to remove this part of the advice process from themselves, which isn’t necessarily a bad thing, but does introduce additional fees.

I am 72 years old and since early 2000 have had 7 advisors. Only the second one was worth anything, but then he passed me on to his assistant as my portfolio was not big enough for him. This is the pattern with advisors, enthusiasm in the beginning, but after a while they ignore the investor, taking their time to respond to emails, not adhering to appointment schedules complete lack of proactive actions. The last one takes the cake. She was employed by FNB and I was told she had worked for many years as an advisor at both Absa and FNB. Well she has cost me thousands and guess what she no longer works for FNB. Am I bitter? Yes.

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