Have fund managers been crying wolf?

Recent performance of balanced funds suggests not.

JOHANNESBURG – For the best part of three years, market commentators and analysts have cautioned that investors need to moderate their return expectations going forward.

And for the most part, markets kept on running.

But in August this year, the local market took a beating and, with the exceptional returns experienced over the last five years still fresh in South African equity investors’ minds, the third quarter was a tough one. According to data compiled by Bloomberg, the FTSE/JSE All Share Index (Alsi) closed at 50 088.86 on September 30 this year, down 3.3% from its June 30 level of 51 806.95.

Yet at the time of writing the Alsi has breached 53 000 points once again and the momentum seems to have picked up. (Although you never know with markets).

Over the past ten years investors on average received roughly 18% per annum from equities. In 12 of the last 13 years, equity returns were positive. The only negative year was 2008.

This is a really difficult situation, says Alan Wood, head of institutional business at Investment Solutions. For a long time the industry has voiced its concern about the sustainability of this performance and yet, equity markets continued to hit new highs.

Eventually this record becomes stuck and everybody stops believing it, he says.

“I think the challenge for investors is that this is a story that we’ve been telling them for three years and they now ignore us because they think we have been wrong.”

What’s happened to balanced funds?

Against the background of exceptional returns in equity markets over the last ten years, many investors may have been disappointed with the recent performance of their balanced funds.

The table below sets out the performance of some local balanced funds over the past year, and compares it with the ten-year picture.

 

Latest 10 years

Latest 1 year

 

Fund

Benchmark

Fund

Benchmark

Fund A (till end Sep)

13.3%

11.8%

3.8%

6.1%

Fund B (till end Aug)

14.8%

14.3%

6.1%

7.0%

Fund C (till end Sep)

13.8%

11.9%

6.6%

3.9%

Fund D (till end Aug)

13.9%

11.5%

8.4%

6.3%

Source: Fund fact sheets

Wood says it is important to look at the performance through the cycle and not to base investment decisions on a one-year picture.

Some balanced funds have even underperformed cash over the last year.

In the long run, investors may reasonably expect to get a return of CPI plus 5% from a high equity balanced fund, but in the short run there may be periods where returns are below inflation, or even negative, he says.

“So it is not just a one-way bet, that is why it is called risk. I think the extreme example of that was in 2003 where bonds actually gave you a better return than equities over a 20-year period. I can remember reading newspaper articles back then suggesting that maybe it is time to just throw out fundamentals of investing in equities and just invest in bonds,” he says.

At the moment there is a risk that investors have forgotten that we go through different investment cycles and are taking on too much risk because they are chasing very good past performance in risky assets, Wood says.

Most members of retirement funds are young and by definition have more than seven to ten years before their retirement date, which naturally means they invest in growth portfolios with a relatively high exposure to equities.

At this point, pension fund trustees may argue that if they had invested in a more aggressive portfolio with a higher equity exposure they would have done better and be tempted to adopt this strategy going forward, as it may seem like the right thing to do for their young members.

“I do think there is a risk there that people think that the last five years are going to be the next five years and invest accordingly,” he says.

Overriding the urge

Wood says it is important for investors to go back to basics. They need to consider why they invested in a specific fund and be clear that the reasons why they invested are still sound.

“I would argue that very often nothing has changed except the experience of the last five years has been unexpected. Make sure that you don’t throw the baby out with the bathwater on your investment strategy,” he says.

Investors need to have a framework to set their strategy that would keep their emotions under control so they don’t corrode that framework.

It may be tempting to switch from a moderate risk portfolio to a high-risk portfolio in order to chase better investment returns.

“Why do you want to do that when the moderate risk balanced portfolio has served you well? The problem is that we are greedy. So fight against that greed, remember why you were there and unless something has changed fundamentally, just stay [the course].”

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