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Choose equity unit trust funds for their strengths

Jun 10 2019 11:17
Schalk Louw

To identify the best of the best, I love to compare and analyse stocks according to different ratios globally. 

Of course, there isn’t necessarily only one right answer when it comes to investment ratios. 

To illustrate this, let’s use two fund managers who practiced at roughly the same time, John Neff and Peter Lynch, as examples. 

Both were very successful in the active management of their clients’ capital and both invested strictly according to specific criteria. 

The main difference between them boiled down to the valuation methods chosen by each. 

Neff was a value investor who focused especially on companies which traded at low price-to-earnings ratios (P/E) and high dividend yields. 

He sold when the fundamental value of the share declined and/or when price targets were reached. 

Lynch was a growth investor who preferred to buy during cyclical recoveries. 

He would start by making a small investment and then invest more and more as conditions improved and prices increased. 

The point is that different ratios outperform benchmarks at different times. 

Those invested in the funds of both Neff and Lynch would be the happiest of investors today. 

Both funds performed amazingly well. 

But, during times where Lynch’s fund would have struggled somewhat, Neff’s fund performed better, which would have resulted in stabilised growth of investors’ returns. 

Local investors often don’t realise that we have similar tools at our disposal. 

Some may want to stop reading at this point, thinking that active management has delivered such a poor performance of late that one really shouldn’t look much further than passively managed funds. 

Sure, but that’s only partly true. 

We have brilliant local fund managers who manage to outperform their benchmarks on a regular basis. 

I analysed the data of all SA general equity unit trust funds by looking at the usual risk versus reward ratios, but also at how regularly these funds managed to outperform the FTSE/JSE All Share Index (JSE), for example. 

Keep in mind: Although fund A might have managed to marginally outperform fund B over the last five years, fund B could still earn a higher rating than fund A. 

If fund B outperforms the JSE 80% of the months in question, while fund A only managed to do so 30% of the time, investors could potentially earn better returns by remaining invested in fund B over time. 

After analysing these funds, I selected the top 15 funds with a total value of R1bn or more. 

With factor investments (investing according to certain themes) in mind, Neff (value) and Lynch’s (growth) methods can also be seen as two different investment themes. 

My personal preferences are value, quality and momentum shares. 

Value investing focuses on shares with a higher earnings yield, lower price-to-book ratio and lower enterprise value-to-earnings before interest, tax, depreciation and amortisation (EV/ebitda) ratio.

Quality shares are valued based on strong returns on equity (ROE) and the lowest possible EV-to-free cashflow ratio, while low-volatility investing focuses more on shares with the lowest possible volatility ratios. 

Momentum investing focuses on shares with a strong increase in price, while avoiding the purchase of shares with declining value.

Over the last five years, several passive investment companies have established exchange-traded funds (ETFs) which only contain shares with either value, quality or momentum characteristics. 

I took the 15 abovementioned funds and individually identified each according to the greatest correlation with either value shares, quality shares or momentum shares. 

Three remained:

- Fairtree Equity Prescient (value)

- Investec Equity (momentum)

- Marriott Dividend Growth Fund (quality)Please note: 

I am not saying that Fairtree Capital, for example, should be labelled as value investors. 

Out of the 15 funds I analysed, they simply had the highest correlation with value. 

Finally, I tested my findings by analysing the performance of a hypothetical investment in all three funds five years ago to date. 

The JSE would have delivered returns of 33% (5.84%/annum) over five years (up to 17 May 2019). 

An investment in these three funds, however, would have delivered a return of 41% (7.06%/annum) over the same period. 

It gets more interesting. 

At a volatility ratio of 12.77%, these three funds combined were 10% less volatile than the JSE. 

The JSE’s worst-performing week resulted in a 15% decline during this five-year period, while the combination of these three funds would have declined by only 13% during the same week. 

Therefore, you would have earned higher returns at lower risk. 

This can probably be attributed to the fact that none of these funds necessarily performed extremely well or poor at the same time, but rather that their respective performances complemented each other over time. 

You would never compile a cricket team consisting of only bowlers. 

Why would you want to approach the compilation of your investment portfolio any differently? 

Schalk Louw is a portfolio manager at PSG Wealth.

This article originally appeared in the 6 June edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

investment  |  value  |  equity
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