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How to approach investing

08 July 2009 Marize Pieters, Glacier Research
Marize Pieters, Glacier Research

Marize Pieters, Glacier Research

Some people like the excitement of the stock market and trade shares via a stockbroking account. This type of investor is solely responsible for his stock selection in constructing his portfolio. While some people are successful in managing their own stock portfolios, this is often not the case. It is extremely risky, a time-consuming process and complicated - with issues such as capital gains tax.

If you don’t like this kind of pressure associated with stock selection, a very popular alternative is to invest in unit trust funds. The cheapest option is investing in a tracker fund that tracks an index like the ALSI40. This is also known as a passive investment and should deliver market related returns. However, due to ongoing fees (albeit very low) your investment will never be able to beat the market. In addition there are a few disadvantages to passive investing that you should be aware of. As an investor you are directly exposed to the emotions and irrationality of the market, which can introduce substantial risk to a fund as was clearly demonstrated in the recent market downturn. Due to South Africa’s rich mining background it should certainly not come as a surprise that half of the index consists of one sector alone, namely resources. Not only is the index biased towards resources, it is extremely concentrated as the top 40 shares make up close to 80% of the index. These factors can add unwanted risk to your investment.

The other alternative is active investing. If you are willing to pay a fund manager an appropriate fee he will actively manage the fund for you, thereby increasing your chances to outperform the market. Although there are many advantages to active investing, a big disadvantage is the endless list of options available (+/- 900 unit trust funds) and the list continues to grow. The variety of funds can suit almost any client’s needs. The crux here is how you make sure you choose the best fund to meet your financial needs with all the additional information in the market. It is definitely not a game of luck anymore and many investors have paid a high price for making uninformed decisions. When you take into account that investment professionals have a local stock market consisting of less than 300 stocks in which to invest, the average man on the street may be immobilized and disheartened by the sheer number of unit trusts out there and may decide not to invest at all. Is it possible that the unit trust industry has become the victim of its own success?

Not necessarily. The industry has changed substantially over the last few years and there are new measures you should take into account when making an investment decision.

So how do you choose a good investment when there are so many options available?

When choosing a unit trust fund there is much more to consider than meets the eye. If you are not an investment expert, source the advice of a qualified financial intermediary who takes the following into consideration when selecting funds in line with your financial needs and risk profile.

The first rule of thumb is to compare apples with apples. Be sure to always compare funds against each other that fall within the same ASISA category (Association for Savings & Investment South Africa) and risk profile within that category, if relevant.

Secondly, do some number crunching by using various quantitative measures when comparing funds with each other, to mention but a few. Cumulative performance is the most popular measure and is the return quoted on every fund fact sheet freely available on the web. However, rolling returns should be used in conjunction with this measure. It removes end-point bias and enables you to get a better understanding of a fund’s under- and over-performance over any period of time. Hence it is a useful method to examine the behaviour of returns for holding periods similar to those you would have experienced were you actually invested in the fund. It is a good way of judging the degree to which a fund manager has been able to consistently add value to the fund. Risk, often referred to as volatility, is also a very important consideration. Rather choose a fund that is able to protect capital on the downside than one with massive swings in performance which increases the volatility of the fund over the short term.

Thirdly, past performance is not necessarily an indication of future performance and it is therefore essential that you combine your quantitative work with some qualitative analysis. When investing in a fund you are essentially picking a fund manager. Hence you want to be assured of his conviction to stick to his investment philosophy and process that delivered this fund’s past performance. Here you should understand their philosophy and process or pick a financial intermediary who does. Make sure the fund is managed according to its stated objectives i.e. a low risk fund should have a high focus on protecting capital in the shorter term. Familiarise yourself with the qualifications and experience of the manager and his team. Find out what other responsibilities the manager has and if this will affect his ability to run the fund effectively. You should guard against funds with excessive fees and if a performance fee is charged understand if it is reasonable. There has been a lot of negativity surrounding performance fees, but if charged fairly it could be of a great advantage as it aligns managers’ interests with that of their clients. Find out if a succession plan is in place to reduce the risk of high staff turnover within the team. These are only some of the pointers to consider when conducting your qualitative analysis.

A fund that scores highly both quantitatively and qualitatively should be a consistent good performer over time. Remember though to monitor your fund regularly. Continue to understand your managers’ latest views and why the fund is performing the way it does. Have realistic expectations and stick to your investment horizon. Don’t let your emotions get the better of you in uncertain times. Trust your financial intermediary and fund manager and let them do what they do best – letting your money work for you.

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