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WHAT IS THE BEST WAY TO ASSESS UNIT TRUST PERFORMANCE?
Investors are often told to evaluate unit trust funds on the basis of long-term performance. How many years are considered to be “long term”?
Also, what yardstick should one use when evaluating performance? Funds have their own benchmarks, but does that necessarily mean that a fund is performing well? Don’t asset managers choose benchmarks they know there is a fairly good chance they will meet? Comparing how a fund has performed relative to other funds in its sector doesn’t seem to be very helpful either, because when the market is doing well, all the funds tend to do well, and vice versa when the markets under-perform. Surely the only benchmark that investors should use is whether a fund out-performed inflation after all fees?
Arnold Hastings
Michael Dodd, an investment analyst at Old Mutual Multi-Managers, replies: It is important to distinguish between the performance objectives of an individual investor and the stated benchmark of a unit trust fund, because these can often be two different things. Although I agree that, in the case of both an individual investor and a unit trust fund, performance should be assessed after fees, because this is a more accurate reflection of performance than gross performance, I wouldn’t necessarily agree that inflation is the “only” appropriate benchmark for an individual investor.
The individual investor’s yardstick for comparison should be linked to his or her investment objective and investment term (time horizon). For example, if the investor is putting away money for retirement and has determined that he or she requires an annual return equal to the Consumer Price Index plus five percent, this is the performance objective against which the investor’s portfolio should be assessed. On the other hand, if the investor is putting money in a low-risk investment in order to preserve capital, a cash-related benchmark would be more appropriate.
Ultimately, the primary measure of success for an individual investor should be whether his or her portfolio has achieved its investment objective over the investor’s time horizon. This measure of success can be extended to assessing fund managers and the unit trusts they manage: has the manager achieved its stated investment objective over the time horizon that it set for itself? This is the primary objective of a unit trust fund and is an important question to ask when assessing a manager. The stated investment objective often takes the form of the fund’s benchmark.
The CFA Institute refers to the acronym “Samurai” in determining whether the chosen benchmark is valid. In accordance with this, a benchmark should be:
* Specified in advance (known at the start of the investment period);
* Appropriate (consistent with the asset class being invested in or the manager’s style of investing);
* Measurable (the benchmark return can be calculated on an ongoing basis);
* Unambiguous (the benchmark is clearly defined);
* Reflective of current investment opinions (the contents of the benchmark are known);
* Accountable (the benchmark is accepted by the manager); and
* Investable (it is possible to invest directly into the benchmark).
Ideally, a fund’s benchmark would be chosen along these guidelines. However, many funds have benchmarks that do not fulfil all of these criteria.
In terms of what constitutes an appropriate period over which investors can evaluate performance, that very much depends on the asset class and the nature of the funds being invested in. Fixed-income funds, for instance, tend be more short term in nature and can be reasonably assessed over shorter time periods than would be appropriate for an equity fund, for example. Multi-asset funds and equity funds often require a longer-term mindset, because volatile market movements have a significantly more pronounced impact on the return profiles of these types of funds. In our estimation, the minimum period over which you can assess these types of funds is five years.
When selecting managers, Old Mutual Multi-Managers aims to identify managers that have an investment process that has delivered a proven track record over multiple time periods. It is highly unlikely that we would appoint an asset manager that does not have at least a three-year track record.
Finally, on peer comparisons: as I mentioned earlier, assessing whether a manager has delivered on its stated investment objective over its stated time horizon should be the primary measure of success. However, managers do not operate in a vacuum, and investors will be cognisant that there are many alternatives that could meet their investment objectives. It is worth remembering, however, that peer comparisons are relative in nature rather than absolute. It is reasonable to expect that, if equity markets are up 20 percent, for example, funds in an equity category will have delivered similar returns.
Peer comparisons are useful, but they come with a number of caveats. First, it is important to ensure that an “apples with apples” comparison is being made. This can be quite tricky, because funds in the same category may have completely different mandates. This highlights the importance of understanding what exactly it is that a fund manager is able to do within its investment portfolios.
Also, it is important to ensure that peer comparisons are made over an appropriate time period. Studies have shown that selecting managers based on one-year performance alone often ends up being a fool’s errand. In our opinion, a longer-term mindset is required when selecting fund managers.
MUST MY PENSION BE TAKEN OUT FOR LIFE?
I am 63 years old. My former employer forced me to take early retirement in February 2015 after it went into liquidation. I have been unemployed for the past year. I am now compelled to withdraw from the Alexander Forbes umbrella retirement fund and buy a pension. The pensions I have been quoted are impossible to live on: R2 200 a month after the one-third lump-sum withdrawal. Does the legislation permit the pension to be calculated over a shorter period – say, 10 years – and not for life?
I have not taken a lump-sum withdrawal previously. Can I withdraw the maximum tax-free amount of R500 000 (my fund credit is R700 000)?
Name withheld on request
Rory Shea, a financial planner at Old Mutual Private Wealth Management, replies: If you did not receive any lump sums on retirement on or after October 1, 2007, did not take a lump sum on withdrawal before retirement on or after March 1, 2009, and did not receive a severance benefit on or after March 1, 2011, you can take the full one-third of your benefit (R233 333), not the maximum tax-free amount of R500 000, as a lump sum and not pay any tax on it.
However, if you received a retrenchment (severance) package from your previous employer, it could affect the tax payable on your one-third lump-sum withdrawal and possibly reduce the amount you can take tax-free. Remember, the total tax-free amount from both retirement fund lump sums and severance benefits is capped at R500 000.
The next R200 000 you withdraw as a lump sum will be taxed at 18 percent, the following R350 000 at 27 percent and the balance at 36 percent.
You cannot buy an annuity for a shorter period; it must be for life.
You could consider the following options to increase the annuity income: reduce the guaranteed term of the annuity; buy a single life annuity (instead of a joint-and-suvivorship annuity); reduce the annual escalation to, for example, four percent instead of inflation; take out the annuity after your 64th birthday (annuity rates are linked to your age); withdraw less than one-third of your savings as a lump sum; or wait for interest rates to increase. However, these options might have a negative impact and should first be discussed with a financial adviser.
You could also invest some of the one-third lump sum in a discretionary investment that would generate an income to supplement your annuity.
Another option is to invest your retirement capital in a living annuity, where you can draw down between 2.5 and 17.5 percent of the capital each year. However, if the credit in your umbrella retirement fund is the only provision you have made for retirement, I would be very hesitant about recommending a living annuity, because you take the risk that the underlying investments will not be able to generate an income for the rest of your life.
Note: Letter writers will be sent the unabridged response that Personal Finance obtains on their behalf. However, published letters and responses will be edited for length and clarity.
Old Mutual Wealth provides integrated wealth planning and goal-based planning through financial planners, backed by global expertise and research. In order to create Old Mutual Wealth, Old Mutual has consolidated the expertise and resources of several established businesses: Acsis, Fairbairn Capital, SYmmETRY Multi-Manager, Old Mutual Unit Trusts, Old Mutual International, Celestis, as well as some investment consulting resources from Old Mutual Actuaries and Consultants. Strengthening Old Mutual Wealth’s position is the recent acquisition of Fairheads Trust Company.