Good fund managers limit loss

Many investors may have wondered whether they should sell out of the current equity market during mid-May. Bear markets are painful and the most recent, in 2002/3, lasted almost a year and left investors who were pegged to the All Share Index with 35% less of their capital. However, research has repeatedly demonstrated how difficult it is to time the market, and the typical investor is likely to get this wrong.

The sensible strategy, says David Crosoer from Advisory Services at SP2, is to invest with an equity manager who can limit losses through good stock-picks. Fortunately, this is not as difficult as it might at first sound.

All equity funds lost money during the third week of May when the market was down more than 7% in its sixth biggest weekly fall since 2000. In extreme market moves shares tend to move together, regardless of their fundamentals. This is particularly true of large down days or down weeks. Even asset allocation funds that can move into cash tend to lose money in such periods because downturns are difficult to anticipate, and managers cant afford to be in cash when markets recover.

What can fund managers do to limit the extent of losses? In a bear market undervalued shares tend to fall less than overvalued shares. Investing with a manager who has a value bias and good stock-picking skills will limit the extent of a funds own fall relative to the market.

Asset allocation managers can also limit losses by moving into cash. But moving into cash is not always desirable. Managers typically go defensive too early, or too late, or miss out when the market recovers. Ultimately, asset allocation managers also need to be good stock pickers to outperform through the equity market cycle.

Good stock pickers track records are confirmed in bear markets, and bear markets are typically the reason a value-based investment style out-trumps a growth style in most long-term studies. Since 2000, the All Share Index has gone through three market corrections of more than 20%. Almost all managers lost money when the markets fell this far. But there are equity managers who have consistently limited losses in these large equity market falls and still participated in the upside when markets recovered. These managers tend to outperform the market over the long term.

Superior stock selection allows managers to restrict (but not eliminate) losses when markets tumble. South African investors are fortunate enough to have good equity managers available that have demonstrated such skill through previous market corrections. Sticking with such a manager is a more effective long-term strategy than trying to consistently call the top (and bottom) of the equity market!

David Crosoer, Sanlam Personal Portfolios