Skilled fund managers shine in tough times

It has been a good time to be invested in the equity markets. Over the past 4 years, the average equity unit trust fund has produced a return in the region of 40% per annum (compared to the long-run equity return of 13% per annum since 1900). It is interesting that the difference in performance between these funds is currently low relative to history. In other words, the performance divergence between the top funds and bottom funds has been low.

This is presented in the table below, which highlights the performance of all General Equity, Growth and Value Unit Trust funds for each of the one year periods starting in July 1997 and ending in July 2007.

Source: Micropal

To help make sense of the chart and table above, we give the following example for the one-year period ending in July 2007:
-the median fund produced a return of 40%
-the best performing fund produced a return of 65%
-the worst performing fund a return of 27%
-the range between the best performing fund and the worst performing fund was 38%

It is clear from the above that the difference in returns between the top and bottom performing funds has been on the low side over the past 4 years, ranging between 23% and 38% (compared to the previous 6 years, which ranged between 36% and 103%).

Note also that in absolute terms, almost all funds have produced returns of over 20% per year for the past 4 years. For investors, this has meant that exposure to almost any general equity, growth or value unit trust over the past four years has delivered very satisfactory absolute returns and little chance of a big disappointment in relative terms. That is a very different picture than for those invested in the more volatile times of 1998-2003, when the difference between being in the best fund or worst fund could have meant a return of +73% versus -30% in 1999 alone!

So what does all this mean? Well, it seems that there have been few opportunities over the past 4 years for skilled managers to show their mettle. A truly skilled fund manager is one that can do better than the market through the complete market cycle (a bear and a bull market). We have analysed South African fund managers with exceptional long-term track records (over bull and bear markets) and our research shows that in aggregate, as much as two-thirds of the total out-performance that these managers delivered was in years when the market was producing below average returns. Similarly, a survey of international managers highlighted that nearly 80% of the outperformance of those managers with exceptional long-term track records was achieved in times of market weakness.

It appears that the very best managers have differentiated themselves in times of poor market conditions and volatility. You should therefore look to managers with a proven ability to add value in bear markets, as it is these managers that become the stars over the long term. This advice may be particularly important now, given that the returns generated by the market over the past four years far exceed the long-run average, and more normalised returns and volatile conditions are likely going forward.

By Matthew de Wet, Head of Investments at Nedgroup Investments