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An investor who wants to invest in the JSE via an investment fund has two main options: using an active fund-management company, usually in the form of a unit trust, or what is commonly known as a passive fund. These are usually exchange-traded funds or unit trust tracker funds.
A passive fund simply tracks the average return of the market. It does this by tracking specific indices such as the FTSE/JSE All-Share Index or the JSE Top 40. Exposure to shares in that index is usually based on the size of the company, with a higher weighting to larger companies. You can never hope to outperform the market in this type of fund, and should receive a return slightly less than the average return after fees have been deducted.
An actively managed fund, run by big household names such as Allan Gray, Investec or Coronation for example, employs professional portfolio managers who spend their days researching all the companies on the JSE and deciding which companies make for the best investments. For this service, they charge a management fee and often a performance fee over and above that. As a result, they are more expensive than passive funds.
The idea is that, with this skill, they will be able to deliver returns in excess of the average return from the stock market, thereby justifying their fees.
The problem is that research is indicating that active fund managers are not delivering on their promises despite, or perhaps because of, their fees.
Research conducted by the Sandamp;P Dow Jones Indices found that, last year, 84% of South Africa’s actively managed investment funds underperformed their benchmarks, which are usually a specified index.
The Spiva SA Scorecard was launched by the Sandamp;P Dow Jones Indices to measure the performance of actively managed South African funds against their respective benchmark indices over one-, three- and five-year periods.
The results raise questions about whether investors are getting their money’s worth by spending money on expensive active management.
As much as 84% underperformed their benchmark last year and, over a five-year period, it was slightly worse: 85% of domestic equity funds underperformed and 97% of global funds trailed their respective benchmarks.
Figures from investment-analysis company Morningstar Direct showed that even when fees were removed, 74% of South African active fund managers underperformed the index over a 10-year period. This means that even if they were charging you no fees, they still did not match the performance of the FTSE/JSE All-Share Index. They were clearly making bad investment decisions.
What underperformance costs you
When comparing the performance of the Sandamp;P South Africa Domestic Shareholder Weighted (DSW) Index (which adjusts the weights of companies in the Sandamp;P South Africa Composite Index to reflect the level of ownership by South African investors) to the average performance of actively managed equity funds, over a five-year period the Sandamp;P South Africa DSW delivered an annualised return of 17.66%, compared with 15.52% from the average performance of active managers.
On an investment of R100 000, the Sandamp;P South Africa DSW would have delivered R240 000. The average performance of actively managed funds delivered R216 000.
The active-versus-passive argument has been around for a long time and, despite the evidence, investors still believe that active management will deliver. Although maybe 85% of them do not, surely there are a group of top fund managers who make up the 15% who do outperform and deliver superior returns?
To test this theory, we went back 10 years to see how the top-performing funds in 2005 had performed against a passive fund that took no active decisions – namely Satrix. We assumed a R100 000 investment in the Raging Bull Award winners for 2005 as well as an index-tracking fund and the information was supplied by Satrix using data from Morningstar Direct.
Multiasset funds
A multiasset fund can invest in equities, cash, property and bonds, so the fund manager’s skill is not only in selecting shares, but in also timing the market – they can decrease exposure to equities if they are worried about a market correction or increase it if they feel there is value in the market.
The 2005 winners were based on performance up to the end of 2004, as calculated by research house PlexCrown Fund Ratings. The 2005 winners across various categories included the RMB High Tide Fund, the Oasis Balanced Fund, the Fraters Flexible Fund, the Investec Opportunity Fund, the Galaxy Balanced Fund and the Stanlib Balanced Fund. These were – in 2005 – the best funds in their category based on the awards.
Ten years later, the RMB High Tide Fund no longer existed and the Oasis Balanced Fund and Fraters Flexible (now Element Flexible) underperformed the average of all the funds in its category.
The Satrix Balanced Fund is in effect a balanced index tracker and would represent a good benchmark for actively managed funds. As the Satrix Balanced Fund was not open in 2005, simulating the index provides insight into how such a passive investment would have compared. When doing this, it’s clear the Satrix Balanced Fund would have outperformed the award-winning active funds.
Of all the funds awarded a Raging Bull in 2005, the Investec Opportunities Fund performed best, and four of the funds did continue to perform above the average of other fund managers, although not the simulated Satrix fund. The Satrix Balanced Fund outperformed all the award-winning active funds, although the point must be made that this was a simulated index and may not have used the same regulatory constraints that were applicable to the funds against which it is compared.
General equity funds
These funds invest across all sectors of the JSE and have no specific investment style. The FTSE/JSE All-Share Index is therefore a good benchmark to track their relative performance. In 2005, the top-performing equity funds were the Old Mutual High Yield Opportunity Fund and the Old Mutual Albaraka Equity Fund. Both significantly underperformed the index over the past 10 years, delivering nearly 30% less than the All-Share Index.
Arguably any data can be manipulated to a certain degree and Ryk de Klerk, executive director of PlexCrown Fund Ratings, points out that the winners of the Raging Bull Awards used in the analysis received their awards based on three years’ performance. A fund that performs well over three years is likely to have a fall-off period.
This means it is virtually impossible to guess which fund manager would fall into that 15% of outperformers, and most likely it is not the same fund manager who outperforms each year. Even if you invested in the best fund manager at the time, it would certainly not guarantee outperformance over a longer period.
The key is to start investing as soon as possible rather than wasting time trying to select a “winner” – because the average performance of the market is likely to build substantial wealth over time.
