The performance standard for collective investments

It is almost impossible to "cherry pick” from among South Africa’s 947 unit trust funds. The challenge for today’s financial adviser (and retail investor) is to determine which of the available funds suits their stated return objective… Tough choices include which category of unit trust to invest in and which fund manager to back in that category.

Plenty has been written about "how not to pick a unit trust”... Top of the list is the oft-repeated caveat: Past performance does not reflect future performance. In other words you cannot simply pick the fund manager at the top of last year’s 12-month performance table.

How should you go about gauging the strength of a particular fund or fund manager? If you buy into the performance measurement ideology then you should consider the results of the Morningstar South African Fund Awards 2012.

Morningstar, Inc. (NASDAQ: MORN) is a leading provider of independent investment research. Unlike the hit and miss one-year tables, these awards recognise funds and fund groups for both one-year and longer term achievements. They avoid giving awards to funds that have posted a strong one-year return but have otherwise failed to deliver good results for investors!

The Morningstar South Africa Fund Awards 2012, announced 12 March 2012, recognise retail funds and fund groups that added the most value for investors within the context of their relevant peer group in 2011 and over the longer term.

Winners are selected using a quantitative methodology developed by Morningstar that considers the one and three year performance history of all eligible funds, and adjusts returns for risk using Morningstar Risk, a utility theory-based screen that imposes a higher penalty for downside variation in a fund’s return than it does for upside volatility.

"2011 was a challenging year for fund managers throughout South Africa. The volatility of the South African market combined with strong global economic headwinds created difficult trading conditions,” said Tal Nieburg, head of Morningstar South Africa. "In spite of these conditions our winning managers relied on skill, experience and solid fund management strategies to deliver top returns to their investors.”

How should financial advisers interpret these "tables”? As already mentioned – today’s top quartile fund is often relegated to the bottom of the performance table in the current year. Instead of obsessing over performance, financial advisers should ensure that their clients understand the return produced under each fund category in relation to their unique portfolio objectives.

Clients must understand that their overall portfolio cannot be chock full of "winning” funds and must accept that a conservative fixed income fund should be measured against similar funds (and benchmarks) and NOT the high-flying equity funds!