How unit trusts help reduce risk

By Andriette Theron, Head of Research at PPS Investments

Andriette Theron

Diversification within the asset management industry can be applied on different levels and can take many forms within an investment solution. With close to R3 trillion invested in collective investment schemes in South Africa, investors are already taking advantage of the diversification benefit on offer by unit trusts. Single-managed funds add value by spreading risk across a broad portfolio of instruments. However, the key market drivers of a fund’s performance result and time horizon of those drivers differ significantly and are often not broadly understood.

The chart below shows all the funds included in the ASISA (South Africa) General Equity category for each of the past 10 calendar years. Even though most funds included in this category aim to outperform some version of a market capitalisation-weighted index consisting of a limited number of stocks listed on the JSE, the range of returns delivered by these funds is very wide for each of the calendar years under review.

Source: PPS Investments, Morningstar, at 31 March 2022. For illustrative purposes only. Past performance is not indicative of future performance.

Despite investing in a diversified fund, the investor could still be exposed to manager specific risk due to the underlying manager’s investment style, their approach to portfolio construction and/or their views on how best to take advantage of the prevailing investment environment.

From the relative ranking table below, it is also clear that it is unrealistic to expect a fund to perform well all the time. Each colour represents one of the 15 largest equity funds currently available in South Africa, while each column represents the relative ranking of the fund in a calendar year. We can see from the random distribution of colours, that it is indeed impossible to predict with any confidence who the best performing manager will be over the next 12-month period purely by looking at recent performance.

Source: PPS Investments, Morningstar, at 31 March 2022. For illustrative purposes only. Past performance is not indicative of future performance.

Even with this in mind there have been numerous studies showing that investors often react irrationally and make poor investment decisions when disappointed by their own short-term returns.

A study was conducted by Fidelity Investments on its Magellan Fund which was managed by the well-respected Peter Lynch from 1977 to 1990. Over this 13-year period the Fund delivered an average return of 29% per year.

The study found that the average investor over this period lost money despite the phenomenal returns delivered by the fund. They concluded that the main reason for poor returns achieved by the average investor in the Fund was the tendency to withdraw from the fund during periods of poor performance only to reallocate capital to the Fund after periods of success.

Instead of trying to time the market by actively trading in and out of funds, we take a long-term, through-the-cycle view and construct solutions that have meaningful exposure to a combination of exceptional managers with distinct return drivers.

Investors can fully extract the diversification benefit by investing in a solution where manager blending is done by combining different but complementary manager strategies. With more than 1500 unit trusts available in South Africa, diversification is readily available.

However, extracting the full diversification benefit that is available is not a straight-forward task and requires extensive resources and a deep understanding of the underlying strategy.

At PPS Investments, we offer a range of single- and multi-managed funds that are carefully researched and constructed to suit most investment needs, risk appetite and time horizon. Through our multi-manager philosophy and in-depth research, investors gain access to exceptional asset managers combined into one solution. We blend an appropriate combination of investment styles and asset classes. These are best suited to take advantage of opportunities at different times in the cycle, thereby offering optimal diversification in portfolios. 

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