One of the biggest challenges to any investor is overcoming their own behavioural biases. A lot of the time, the biggest risk to our wealth is ourselves.
Studies in behavioural finance have shown how investors often act irrationally and are swayed more by emotion than reason. One of biggest behavioural biases we face is that we overestimate our own abilities. We think we are smarter than we actually are.
This is what leads a number of investors to think that they can pick the best fund from year to year. They believe that they have the ability to earn better returns by moving between unit trusts than simply sticking to one manager over the long term.
To show how difficult this really is to do, Moneyweb conducted an analysis of the performance of 12 unit trust categories over the past ten years. Using category averages provided by Morningstar, we rated them from top to bottom for each year.
As the chart below shows, the performance of these categories varies considerably from one year to the next. In other words, you can forget about trying to pick the winning fund, as it’s almost an impossible task just picking the winning category.
Source: Moneyweb & Morningstar
The first thing to take from this chart is that it has only happened once in the last ten years that the best performing category one year was once again at the top the following year. That was in 2014 and 2015 when global real estate funds were the top performers. It is however worth noting that in the next year, this category featured as the second worst.
This illustrates how dangerous it is using past performance to predict future returns. The returns from a category of funds in one year is no indication of what those funds will do in the next 12 months.
It is also worth noting that some categories are far more volatile than others. As one would expect, the South Africa small/mid cap equity category is one that shows very variable performance from one year to the next.
However, the most volatile category is actually global interest bearing short-term funds. Most investors wouldn’t associate bonds with volatility, but returns for South African investors from global bonds have been far more volatile over the past decade than from any other asset class. The currency has a lot to do with this, but over this time period this category has twice been the best performer, and four times it has been the worst.
Some investors will also be surprised by the volatility in South African interest bearing variable term funds. Again, these funds predominantly invest in bonds, which would usually be considered more stable. However, because these funds can invest in a much wider range of instruments than short-term bond funds, their returns will vary more widely.
The categories that have been most stable from year to year are the South African multi-asset high equity and Worldwide multi-asset flexible funds. This is really what investors would expect from these portfolios that can vary their asset allocation to suit changing market conditions. They should therefore produce far more predictable returns than funds limited to a single asset class.
The final point worth making is how much of an impact the currency can have on this table. The returns over the past two years illustrate this best.
In 2015, the rand depreciated sharply, and all the global and worldwide categories outperformed all the South African categories. Last year, exactly the reverse was true.
Given that how difficult it is to forecast the exchange rate, this should be yet another reason to discourage investors from trying to pick the winning category from year to year. The best approach is always to have a diversified portfolio that will grow over time, rather than trying to predict short term market movements.