Considerations when investing in equities

Rushil Jaga, Glacier Research

As investors we often classify a poor investment as one that provides a return of zero or less. Anyone who has committed money to the equity market within the last two years is probably placing this asset class into that very classification. However, a true indication of asset manager skill is obtained by evaluating these returns (be it positive or negative) against an appropriate benchmark. In this instance the appropriate benchmark for an equity unit trust fund would be the JSE All Share Index. While performance of various asset managers is sporadic in the short term, it is interesting to observe that most South African equity managers struggle to beat the index over the longer term. Poor investment decisions, high fees and fund manager turnover are just some of the reasons these managers have failed to beat their benchmarks. This problem is compounded by emotions, as knee-jerk reactions cause investors to move in and out of the market via unit trust funds.

An interesting study conducted on the US equity market by investment guru John Bogle showed how both fund managers and investors destroyed value by making these emotion-fueled decisions. The study showed that the S&P500 index delivered an annualised return of 13% over the past 20 years, whereas the average manager and average investor achieved returns of 10% and 7% respectively over the same period. The “short-termism” of these investors ultimately led to their demise.

Have South African equity managers fallen into the same trap? Looking at the performance of these managers over the past 10 years reveals that success (measured by outperformance of the JSE All Share Index) has been limited. The Association of Savings and Investments South Africa divides equity managers into general, value and growth styles. Across these disciplines, only 33 managers have a track record of 10 years and longer. Of these managers, only 11 managed to outperform the JSE All Share for the 10 year period to the end of the second quarter of this year. The funds that were successful in beating the benchmark were generally those which had a value style bias (buying companies at a discount to intrinsic value). Growth managers struggled over this period as all these managers underperformed the index. In fact, the worst performing fund was a growth fund which managed to deliver a return less than cash (before tax). Thus the selection of a particular manager and the investment management style are equally as important as deciding to introduce equities into an investment portfolio.