Selecting the wrong time and the wrong fund to invest in is something that happens daily. Industry flows and years of research show that investors habitually chase performance and are notoriously bad at timing the markets, which often has severe consequences.
In general, investors face the risk of picking a fund that can either perform well or poorly, depending on a number of variables. These decisions will ultimately influence the probability of losses relative to the expected return on their investment. Investors erroneously look at historical performance for guidance to help them make these selections, and overlook the general rule of thumb in investing, which warns against assuming that an investment will continue to perform well simply because it has done so in the past. The same can be said about overlooking an investment simply because it has gone through periods of underperformance recently, as it may well improve in the future. It is important to remember that trying to predict what markets will do next, and which funds are likely to outperform, is close to impossible.
Diversification is your best bet for surviving market volatility
Multi-asset funds offer exposure to a broader range of asset classes that can act as a buffer against volatile markets. Investment returns vary significantly between different asset classes, which can provide some protection against major losses in your portfolio. When one asset class underperforms, the others can pick up the slack.
Out-of-favour SA assets and selected bonds are set to generate superior returns, but investors are likely to be behind the curve. Recent market volatility and the uncertainty from the pandemic have driven investors away from diversified local funds, towards more conservative products such as cash and/or offshore opportunities. Yet, available data shows that returns from cash investments are relatively low, while risks in the credit space remain high. Following the market downturn last year, the local currency and the South African equity market have recovered. To date, the rand has recovered from record lows of R19/USD recorded in March 2020, reaching an intraday best of R13.76/USD on 26 May 2021. The FTSE/JSE All Share Index (ALSI) has also added approximately 75% in value since March 2020, with some funds generating well over 100%. Moreover, data from Morningstar at the end of March 2021 shows that the South African Equity General sector (SA equity funds) has recorded over R1.5 billion more in net flows than it did in the previous year.
Selection risk is high at the moment
The difference between the best-performing and worst-performing funds in the ASISA Equity General sector (SA equity funds) is near record-high levels. The cost of making the wrong selection calls is severe and now is a good time to think very carefully about how you go about selecting assets to construct your portfolios.
The top-performing funds in the ASISA Equity General sector category in 2020 are now trading at the bottom of the pack, with those funds that lagged last year outperforming this year.
If investors chose to invest in one of the top-performing funds of 2020, they would have made a loss this year. This demonstrates that selection risk increases when investors pick previous winners simply based on performance numbers.
Delegate security selection and asset allocation functions to experienced professionals
Rather than chasing higher yields and assuming more risk in the process, you’re better off having a portfolio that’s sufficiently diversified with a proven track record of smooth returns. We continue to recommend that investors should be invested in multi-asset funds that diversify across the asset class spectrum, both locally and abroad, as per their wealth managers’ outlook on prevailing market conditions in their respective geographical areas. We believe, now more than ever, that investment tilts should be made towards local growth assets.