South Africans should be relatively encouraged by the rising values of their retirement and savings plans at the start of 2011. This is courtesy of gains in global equity, commodity and credit markets as the global recovery gathers momentum and interest rates remain at record lows in developed regions. Emerging markets have outperformed, with the local equity market again approaching record highs.
The problem for investors is that they rarely get the full benefit of market performance. While there is no comparable research for South Africa, findings on investor returns by US firm Dalbar Inc show that over the 20 years to the end of 2009 the average US investor earned 3,2% in US equity mutual funds compared to the US market return of 8,2% – suggesting that fund switching is effectively destroying value. According to Richard Carter, head of product development at Allan Gray, the picture is much the same in South Africa.
“Some investors try to improve their returns by switching out of one fund into another; but often switching destroys value. Selling unit trusts that have temporarily dipped below their average performance in order to buy funds that are briefly punching above their weight can be part of a destructive sell-low, buy-high cycle,” he says.
The misery of choice
Pieter Koekemoer, head of personal investments at Coronation Fund Managers, points out that South African investors can choose today from a total of 943 active unit trusts (12 years ago there were 186 funds).
Koekemoer confirms one of the biggest risks presented by such a vast array of funds is that investors may be tempted to switch out of certain funds at the wrong time for emotional reasons, such as selling out of a particular market sector when it is at its lowest. Though past performance is no guarantee of future performance, it can be enlightening to look over the past year. Statistics provided by Rand Merchant Bank (RMB) Unit Trusts place listed property funds as the top performing unit trust category last year with an average return of 24,06%. Investors in domestic general equity funds enjoyed an average return of 18,06% with funds holding substantial industrial exposure (especially retailers), providing significant outperformance.
Industrial counters returned 20,46% over the year and financials 12,02%. Returns for local resource stocks were restricted to 10,19% as a consequence of the strong rand, despite a substantial 14,79% gain in US dollar (USD) commodity prices as represented by the Goldman Sachs Commodity index (measured in USD). The rand appreciated from R7,39/USD to R6,61/USD over the period.
This also negatively impacted international fund returns even with a 10% gain in the MSCI World index. Bond funds provided substantial average returns of 14,70% as inflation and interest rates fell more than expected. Money market funds by comparison experienced disappointing absolute average returns of 6,87%.
A return to balanced funds
John Duncan, technical marketing manager at RMB Unit Trusts, says: “The unit trust industry continues to witness investor risk aversion and a preference for asset allocation funds (also known as balanced funds) relative to specialist funds. This is evidenced by continued substantial flows into money market and cash plus funds, despite the significant outperformance of equities and record low interest rates.
“Asset allocation funds in the low equity category provided an average return of 9,62% last year while funds in the variable equity space returned 10,91%,” says Duncan. He notes that investors appear more sanguine on macro issues such as the Eurozone debt crisis, economic prospects for the US and the threat posed to Chinese economic prospects by monetary tightening. “They should however temper their expectations for portfolio returns this year given relatively expensive domestic equity valuations after the market’s advance over the last two years,” he says.
“Sentiment towards emerging markets also appears to have waned as spiralling food prices stoke inflation. This has resulted in an increased threat of severe monetary tightening. Developed markets by comparison appear to have a more favourable monetary backdrop. This is supported by subdued inflationary pressures and policymakers remaining reticent to raise interest rates for fear of undermining fragile economies.
“Equity markets in developed regions should thus track higher, but bonds are likely to come under pressure as spare capacity declines and banks start lending again. This, together with relatively elevated property vacancies, tempers return expectations for listed property,” says Duncan.