Unit trusts have always been the primary vehicle for private investors to gain access to equities for their well-documented benefits: diversification, ease of buying and selling, their low-cost entry, and transparency.
However, given the drubbing that equities have taken over the past year (the JSE is 32% off its peak, and 26% down for the past 12 months), it is worth reviewing the case for investing in unit trusts.
When investing, there are a number of decisions to be taken: which asset class (equities, bonds, property or cash – each can be accessed via unit trusts), and whether to go passive or active.
Mark Lindhiem, Investment Solutions head of manager research, says that over the 12 months to April the best performing asset class was bonds (+15%), while inflation-linked bonds returned +12%, the money market +12% and income funds (with an element of bonds) +13%. Domestic general equity funds did worst, producing a negative return of –24,6%.
During the past year, R50 billion flowed into the money market, and a third of all investment capital is now in the money market. This reflects the cautiousness of the average investor. However, these results cover a 12-month period during which a great deal happened. During each successive reporting month, the return of equities worsens, but this is disguising the true state of the equities market that has enjoyed a strong rally for the past two months. When reporting over a 12-month moving average it takes some time for the upturn to be reflected in the figure.
Bull runs & bear markets
Lindhiem says active managers of general equity funds tend to underperform the market in a bull run because they are invariably underweight resources, which make up a high proportion of the total market capitalisation, and had a terrific run last year.
On the other hand they outperform in a bear market for the same reason, and that outperformance has increased by 1,5% in just two months – reflecting the sharp improvement in equities.
Armien Tyer, managing director of Sanlam Investment Managers says the returns on the money market and bond markets are due to fall, given the 450 basis points drop in interest rates so far this year.
It therefore appears that the returns over the next 12 months will be quite different from the past 12.
Tyer says there is no blanket answer to what an individual should invest in. “It is a function of his risk profile and cash flow needs.”
On the question of whether or not to opt for an active manager, one who actively trades to try to outperform the overall index, at the end of December last year the index had outperformed the average general equity unit trust, suggesting investors would have done better selecting one of the JSE’s index funds.
For this reason, Tyer advises private investors that they would be better off with passive funds, such as one of the Satrix options. This way, one buys the index, without the costs of paying for a fund manager.
“For those who decide not to go for an index fund, the best choice would be a balanced fund. Most people cannot handle the short-term volatility of the equities market, despite the fact that equities traditionally outperform every other asset class over the long-term.
“Another option is a targeted fund, which seeks to deliver a real return. While these haven’t met their inflation-linked returns over the past year, most fulfilled their mandate of protecting investors’ capital during this bear market,” says Tyer. Coronation chief investment officer, Karl Leinberger, summarises the current market:
“Making predictions about short-term return expectations for risky asset classes is difficult and can only be done within broad parameters and the caveat that the margin for error is extremely high. We therefore recommend investment terms of at least three years or longer for most unit trust funds.
“We do however know the following: Short-term interest rates will continue to decline, making the hurdle rate presented by the expected return on cash holdings easier to clear; domestic longer-dated bonds remain on the expensive side, with significant risks presented by a fairly sticky inflation environment and much more demand coming on stream; equities are at worst fairly valued and at best significantly undervalued,” says Leinberger.