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Considerations when choosing funds and managers

15 September 2021 David Crosoer, Chief Investment Officer at PPS Investments

Over the past decade, there has been a surge in the number of unit trusts that South African investors can choose from. Currently, there are well over one thousand unit trusts available. Yet, close to one quarter of all unit trust assets sits in the 20 largest funds, according to Morningstar. Further to this, one third of assets is invested with just three out of the 44 asset management companies in South Africa.

When delving deeper into the behaviour of investors, statistics from the Association for Savings and Investment South Africa (ASISA) show that more than half of local investors’ fund assets are spread across just three of the fund categories: South African Multi Asset High Equity, South African Equity General and the South African Interest Bearing Short-Term category. Perhaps this reflects the important historical role that funds played as a vehicle for retirement savings (in the South African Multi Asset High Equity category), general SA equity market exposure (South African Equity General category), and an alternative to saving through a bank account (South African Interest Bearing Short-Term category).

Nevertheless, there are ASISA categories that are less constrained by pension fund regulations (e.g. the Worldwide Multi Asset Flexible category where funds can invest up to 100% in equities or foreign markets) or the narrowness of the SA equity market (e.g. the Global Equity General category) or less constrained by record low short-term interest rates (e.g. South African Interest Bearing Variable Term category) that are magnitudes smaller in size than the three large ASISA categories, despite them offering far more investment opportunities.

At the same time, there are asset management companies with robust investment processes and organisational incentives closely aligned with yours, but whose brand may not be well known. How might you incorporate these into your investment portfolio?

Perhaps the starting point is accepting that good managers are not easy to find, so investors may need to be more open-minded about how to access them. If you are invested much like everybody else, and mainly favour funds everyone has heard of, are you aiming to outperform the average? More to the point, is manager skill disproportionately distributed in just a couple of ASISA categories and management companies?

There is a range of asset managers locally to choose from with different investment philosophies, approaches and styles, and investors will need to understand how these managers will behave in different market cycles. Let’s look at some aspects to consider when assessing, comparing, selecting and blending managers.

What to look for in a manager

When assessing a manager’s capability, it is important to consider where the manager is likely to perform best through their specialist capabilities.

Typically, one needs an in-depth understanding of each manager to identify how easily its investment edge is transferable across multiple categories, and where its investment skills lie. When considering managers with less established track records, qualitative judgement becomes even more important, while the sustainability of the business should also be an important consideration.

Start out by trying to select managers that you think are above average over time. While the past is not necessarily an indication of the future, it can establish whether the managers have previously demonstrated they might have skill. Where managers can use multiple assets classes, compare them against their peers. Where managers are trying to outperform a single asset class, compare them against a market capitalisation benchmark. Try not to focus too much on recent short-term performance (or performance that happened a long time ago), but also consider why the fund might have an enduring edge.

Fund of Funds or multi-managed funds can also provide an easy entry to diversified manager portfolios. It’s important that the multi-manager can explain how it identifies above average managers and that its track record demonstrates a more consistent performance profile.

At PPS Investments, we believe that you should have access to different investment styles to build a sensibly diversified portfolio, without you having to expend resources to do this. As such, we offer a range of single- and multi-managed funds that are carefully researched and constructed to suit your investment needs, risk appetite and time horizon. Through our multi-manager philosophy and in-depth research, you gain access to the country’s top asset managers combined into one solution. We blend an appropriate combination of investment styles and asset classes. These are best suited to take advantage of opportunities at different times in the cycle, thereby offering optimal diversification in your portfolio.

There is no magic number of how many funds to include in an investment portfolio, but most investors are probably under-exploiting the asset manager skill set that could be accessed in a portfolio, especially given how concentrated in relatively few strategies and funds investor assets are today. While the South African landscape has encouraged asset managers to launch more funds than is necessary, it has also made it harder for investors to identify which funds have an enduring edge.

Regardless of what you decide to do, remember that one of the major drivers of why you will underperform the average manager is not because you didn’t hold enough managers, but rather because you tried to make too many changes to your line-up of managers. So whatever strategy you choose to adopt, you need to commit to having confidence in your managers as the future will continue to surprise.

Quick Polls

QUESTION

South Africa’s Financial Sector Conduct Authority (FSCA) has the power to raise revenues by issuing administrative penalties and fines against non-compliant financial services providers, with this money flowing back to the Treasury… Does this, in your view, create a regulatory / government conflict of interest?

ANSWER

Absolutely, as conflicted as it gets
Maybe, I’m on the fence on this
No, the FSCA can do no wrong
The guilty must pay
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