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So you think you can pick next year’s winning fund?

Analysing unit trust category returns over the past decade shows how difficult it is predicting which funds will outperform.

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. 

table

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.

 

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Is there anyone here that thinks they can predict the top performing unit trust category for 2017? Lets hear it.

Even better would be naming the top performing unit trust. We can then come back to this article in Jan 2018.

Global small cap funds, we can reconvene in exactly one year and see if I was right.

Your average retail investor should no more be trying to pick winning unit trusts than they should be stock picking. Find an advisor or investment house whose approach you believe in and then put your money in funds with them that suit your risk profile. Then leave it there for a long time. It’s the only way you’ll capture decent long term returns and grow wealth. They’ll give you returns close to the market, or hopefully slightly above, and you’ll do better than trying to time entry and exit points and finding next years winners – which is a sure fire way to underperform the market. And paying an advisor fees will not detract from returns. If they’re any good, they’ll do their job, which is to stop you doing making bad choices at market extremes and keep you invested sensibly through the cycle, giving you much better returns than you’d get by trying to time entry and exit points.

Well said Alaric, agree with that entirely but ensure all ongoing fees are fully disclosed and sensible. Avoid investing via life insurers and say no to any upfront commissions.

Upfront commission has much less of an impact on returns that ongoing fees in the longer run.

Pokkel how do you think the Life Offices recoup the Upfront Commissions they pay advisors? Ongoing admin/platform fees which are through the roof. I have seen admin fees north of 4%pa on some of these life office RAs and endowments etc. And if the poor investor dares reduce or cease their contributions then they hit them with outrageous surrender penalties to recoup again. Awesome!

I agree with you regarding endowments and Life office RA’s. I was referring to discretionary investments and Living Annuities.

Often broker will tell clients that they take no upfront commission but then take a advice fee of 1% p/a. It would be better to pay a once-off fee of 2% and not pay any advice fee in future over the longer term.

Patrick, you missed one observation: Sure, the top ones don’t stay top, but neither do (most) bottom ones stay bottom.

It seems to me in most cases picking the worst sector, sees it rising to the top (half) in 1-2 years…

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