Side-stepping fees could leave you out of pocket

Over the past decade the percentage of direct purchases of Collective Investments Schemes (CIS) funds has increased from 18% to 28%. Private investors are shunning financial advice and making their own fund selections. It’s a decision that could prove costly over the longer term.

The South African Collective Investment Schemes industry manages in excess of R750 billion in 910 funds. Last year the industry recorded net cash inflows of R92 billion. Most of this cash – whether from retail or institutional investors – bolstered funds with conservative mandates. JSE-listed shares could only attract R10.8 billion of this cash despite returns in excess of 32% for the year.

Market analysts remain confused by cash flows in the unit trust space. They know that an appropriately structured unit trust portfolio can satisfy the most demanding risk / reward profile. It’s as if private investors are encouraged to ‘go it alone’ by the apparent ease of buying and selling the products. Is the average investor ready to construct a unit trust portfolio without financial advice?

Constructing a portfolio

To answer this question let’s consider the steps you have to take to build a unit trust portfolio. Your first decision is which unit trust category to invest in. You can choose from Equity, Asset Allocation, Money Market and Fixed Income. This is where non-advice consumers tend to make their first mistake. They adopt an extremely cautious approach and inevitably sacrifice potential equity returns for the security of money market or fixed income unit trusts. This tendency is clearly reflected in the latest industry statistics that show 72% of all assets in money market funds originate from retail investors.

Let’s say you avoid the beginner mistake and decide to invest in equities. At face value the equity class appears straightforward enough. All you have to do is decide which of the eight equity sub-categories are likely to outperform over the year. Your choices include general equities, value shares, growth shares, small cap shares, etc. But there are few guarantees. In 2009 the average Equity Value unit trust outperformed Equity Small Cap funds by a massive 11%. Picking sectors is extremely difficult, even for seasoned asset managers.

Selecting the management company

Your task doesn’t end after you’ve decided on a category and sub-category. At this stage you need to select a management company – preferably with a solid track record – and sieve through the multitude of unit trust funds offered by it. This is the perfect opportunity to make the second non-advice error. Private investors rely too heavily on historic performance. They sink billions of rand into last year’s top performing funds.

What’s wrong with backing a winner? Put bluntly, past performance is not an indictor of future performance. Studies have found that if you invest each year in the previous year’s top performing unit trust, your 10-year performance will be worse than if you’d bought the worst performing fund!

Avoid the traps

The CIS industry offers an array of sophisticated financial products that can be tailored to suite exact financial needs. Investors are well-advised to avoid the trap of selecting their own unit trust portfolio simply to avoid paying fees.

Investors may think the 9% per annum compound return earned on a money market investment over five years is impressive, but it pales against the 16% to 22% annualised return from equities over the same period. A financial planner can structure a balanced unit trust portfolio with a solid equity underpin and an appropriate spread of risk and risk-free funds.