To chase or not to chase?

Kamil Maharajh, Investment Analyst at Glacier by Sanlam.

Given the nature of the investment environment, more and more investors base their financial decisions on past performance.

SA Multi Asset Income & SA Multi Asset Low Equity

Switching from funds that have performed poorly to the top performers in a short period may not always be a prudent strategy. Investors need to understand that short-term performance should not be the sole purpose to invest in a unit trust. To improve their chances of success they must be willing to sit through volatile markets and avoid the ‘thrill of the chase’.

I conducted this study in all the Multi Asset categories and the General Equity category for the 10 years ending 2014. I started in 2004, working through each year’s performance data incrementally, picking the best performer from the previous year and then investing for the current year, doing this over and over for 10 years. I then also implemented a two-year holding strategy for each fund before switching to the best performer. We are essentially chasing the best performers. I then compared these to a number of quality funds we could have invested in and held for the entire 10 year period.

This is a summary of the strategies I will be referring to in this paper:

These simulations were conducted following two scenarios. The first scenario began with the best performing fund outright while the second scenario began with the same fund that was being compared to the buy and hold strategy’s value. These values were then compared to the buy and hold values to demonstrate which strategy would have given a higher return over the 10-year period.

SA Multi Asset Income

In the SA Multi Asset Income space there were 11 funds with a 10-year track record or more, that existed in 2004.

These are the funds and their annual performances in 2004:

On a qualitative basis, the Coronation Strategic Income fund would be the fund that we would buy and hold for the term. I then began 2005 by investing R100 000 in Personal Trust Income as it was the best performer in 2004. In 2005, the best performing fund was again the Personal Trust Income, which I then selected as my 2006 investment. I continued this same selection process for each year until 2014. I compared scenarios using one- and two-year holding periods before switching.

By the end of the 10-year period, if we bought and held the Coronation Strategic Income fund, we would have accumulated R245 907.68 at 9.42% p.a. The Chasing 1 strategy and Chasing 2 strategy, which chose the best performing fund initially, would have accumulated R229 141.38 @ 8.65% p.a. and R233 238.64 @ 8.84% p.a. respectively over the same 10-year period. The Buy & Hold strategy, using the Coronation fund, would have returned 7.32% and 5.43% more than the Chasing 1 and Chasing 2 strategies respectively.

Similarly, if we had selected the Coronation fund initially in both the Buy & Hold and Chasing strategies and then began switching, we see a similar trend. The Buy & Hold strategy outperformed both the Chasing 1S and Chasing 2S strategies by 16.37% and 13.64% respectively.

Source: Morningstar and Inet

Graph 1 – The above graph shows the Buy & Hold strategies for each fund, divided by each Chasing 1 and Chasing 1S strategy. A positive percentage indicates the outperformance of the Buy & Hold strategy relative to each of the chasing strategies by the end of the 10-year period.

Source: Morningstar and Inet

Graph 2 – The above graph shows the Buy & Hold strategies for each fund, divided by each Chasing 2 and Chasing 2S strategy. A positive percentage indicates the outperformance of the Buy & Hold strategy relative to each of the chasing strategies by the end of the 10-year period.

It is clear to see that holding a quality fund, such as Coronation Strategic Income, would have beaten a chasing strategy in any scenario that we run. The skill of managers shines through, enabling them to outperform inefficient markets and ‘normal’ investors.

SA Multi Asset Low Equity

I then ran this simulation on the SA Multi Asset Low Equity space. There were seven funds with at least a 10-year track record that existed in 2004.

These are the funds and their annual returns in 2004:

From a qualitative basis, Prudential Inflation Plus would be the fund that we would buy and hold for the term. I then began 2005 by investing R100 000 in Element Real Income as it was the best performer in 2004. In 2005, the best performing fund was the Prudential Inflation Plus fund, which I then selected as my 2006 investment. I continued this same selection process for each year until 2014. I compared scenarios using one and two year holding periods before switching.

By the end of the 10-year period, if we bought and held the Prudential Inflation Plus fund, we would have accumulated R351 554.79 at 13.4% p.a. The Chasing 1 and Chasing 2 strategies, which chose the best performing fund initially, would have accumulated R256 714.43 @ 9.9% p.a. and R225 976.41 @ 8.5% p.a. respectively by the end of the same 10-year period. The Buy & Hold strategy, using the Prudential fund, would have returned 36.9% and 55.6% more than the Chasing 1 and Chasing 2 strategies respectively.

Similarly, if we had selected the Prudential fund initially in both the Buy & Hold and Chasing strategies and then began switching, we see a similar trend. The Buy & Hold strategy outperformed both the Chasing 1S and Chasing 2S strategies by 25.6% and 38.2% respectively.

Source: Morningstar and Inet

Graph 3 – The above graph shows the Buy & Hold strategies for each fund, divided by each Chasing 1 and Chasing 1S strategy. A positive percentage indicates the outperformance of the Buy & Hold strategy relative to each of the chasing strategies by the end of the 10-year period.

Source: Morningstar and Inet

Graph 4 – The above graph shows the Buy & Hold strategies for each fund, divided by each Chasing 2 and Chasing 2S strategy. A positive percentage indicates the outperformance of the Buy & Hold strategy relative to each of the chasing strategies by the end of the 10-year period.

In this study, we have seen that buying and holding a quality asset manager’s funds will outperform a strategy which chases the best past performers, by leaving the asset allocation decisions up to the asset managers and taking a long-term view. Longer holding periods of funds also delivered better returns than switching over very short terms. Being able to withstand short-term volatility and remain invested in the markets proves to be the prudent, most rewarding strategy time and time again when considering established, highly experienced asset management houses with proven track records.

At Glacier Research we believe that investing is a long-term view and switching between funds when markets go through a little turmoil is not a prudent investment strategy.

I will be publishing Part II and Part III of this study soon.
Part II will look at the SA Multi Asset Medium Equity and SA Multi Asset High Equity ASISA categories while Part III will look at the SA Multi Asset Flexible and SA Equity General ASISA categories.