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Are multi-asset unit trust funds 'broken'?

Personal Finance

Many unit trust investors whose money was put into local investment markets have earned disappointing returns over the past three years: only as much as – or, in some cases, less – than they would have earned if they had invested in cash.

The top-performing money market unit trust fund returned just over seven percent a year over the three years to the end of March; the average annual return from money market funds over the period was 6.59 percent; and the benchmark for cash, the Short-term Fixed-interest Index, returned 6.77 percent a year.

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The average annual return of the popular equity general funds, which invest across all sectors of the JSE, was only 4.55 percent over the three years to the end of March, while the FTSE/JSE All Share Index returned 5.98 percent a year over that period.

Investors exposed to bonds earned only seven percent a year over the past three years, while the FTSE/JSE All Bond Index returned 7.45 percent a year.

The asset classes in which investors earned good returns were listed property – on average, funds returned 14.48 percent a year over the three years to the end of March – and global equities and global real estate, with average annual returns of 12.29 percent and 11.79 percent respectively.

Investors who entrusted their money to managers of balanced, or multi-asset, funds, expecting the managers to allocate their money to the asset classes with the best prospects, also have reason to be disappointed with the returns they earned over the past three years.

The most popular multi-asset sub-category, the high-equity funds, on average returned only 6.34 percent a year over the past three years. The second most popular sub-category, the low-equity funds, on average returned 6.71 percent a year.

In response to these returns, one leading financial adviser has asked whether multi-asset funds are “broken”.

Craig Gradidge, an independent financial adviser at Gradidge-Mahura Investments, says in a blog post that low exposure to listed property – in most cases, only about five percent – and high fees have taken their toll on the performance of many local multi-asset high-equity funds over the past three years.

“Fund managers have been chronically underweight in listed property for many years. This has led to investors losing out on the excess returns provided by the asset class for an extended period. Fund managers have consistently called the listed property sector wrong and have cost investors potentially billions of rands in returns over the past 15 years,” he wrote.

This is one of the reasons passively managed multi-asset funds have out-performed over the short term: the managers of these funds do not take a view on asset classes, Gradidge says. Passive multi-asset funds typically have between five and 10 percent in listed property, he says.

Passively managed funds also have lower investment fees.

Gradidge notes that the three passively managed multi-asset funds with three-year track records have out-performed the average annual return of the multi-asset high-equity sub-category.

The three funds are the Nedgroup Investments Core Diversified Fund, with an annual return over three years of 7.88 percent, the Sygnia Skeleton Balanced 70 Fund, with an annual return of 7.5 percent, and the Satrix Balanced Fund, with an annual return of 6.84 percent.

Gradidge says that when returns are low, as they currently are, fees have a significant impact on returns. “A fund with a 1.5-percent-a-year fee would have needed to deliver a total return over the past three years of 25 percent before fees in order to out-perform cash on an after-fee basis.”

Gradidge notes that although there are managers who charge 0.6 percent a year to manage a multi-asset fund, the bigger managers tend to have total (including performance fees) investment charges of more than 1.7 percent, and many funds have fees of more than two percent.

He says another area where asset managers have failed investors has been in making the right rand hedge and offshore asset allocation calls.

Gradidge says many multi-asset funds under-performed last year, because they had the maximum exposure to offshore shares and rand-hedge industrials while the rand was stronger.

Some smaller boutique managers, such as Bridge, Obsidian and ClucasGray, are examples of active managers that were positioned for a stronger rand last year, he says.

Despite multi-asset funds’ less-than-stellar performance over three years, Gradidge says the picture is brighter over the longer term: multi-asset funds’ average returns were higher than cash and bonds, although they still under-performed equity and listed property funds.

Fortunately, many South African investors have invested in one or more of the five largest multi- asset high-equity funds managed by Allan Gray, Coronation, Foord, Investec and Prudential, and these funds have sound long-term track records, Gradidge says.

However, he says if the current market volatility persists, it could be harder for expensive multi-asset funds to deliver value to investors.

Although multi-asset funds may not be “broken”, investors should pay more attention to fees and asset allocation, he says.

He encourages investors to diversify their investments across active and passively managed multi-asset funds and to use managers who use strategic or a fixed asset allocation to each asset class and those who practice tactical asset allocation (actively changing the allocation in line with the manager’s view).


TAKE A LONG-TERM PERSPECTIVE

The past three years have been very difficult for managers of equity and multi-asset funds, but equity markets often have periods of under-performance, and long-term investors should not be concerned, the manager of a multi-asset fund with a 20-year history says.

Graham Tucker manages the Old Mutual Balanced Fund, which returned 6.99 percent a year over the three years to the end of March. However, the fund has returned an average of 12.32 percent a year over the past 20 years (according to ProfileData).

Tucker says local equities have produced negative real (after-inflation) returns in 30 of the 92 years since 1924, and 2015 and 2016 were two of those years. Real returns in 2014 were less than 10 percent. 

He says other asset classes, such as bonds and listed property, have recently delivered better returns than equities, and the Old Mutual Balanced Fund did increase its allocation to these asset classes above what it regards as its usual allocation.

However, the fund is focused on delivering inflation plus four to five percent over a five- to seven-year period, and to achieve this it has to be invested in equities, he says.

Tucker says that, over the past year, the fund raised its allocation to listed property from three to seven percent. Multi-asset funds that are offered to members of retirement funds and that comply with regulation 28 of the Pension Funds Act can have an exposure to listed property of up to 25 percent.

But Tucker says a high exposure to listed property introduces the risk of not being able to get out of those stocks if the manager has to. 

He says listed property has experienced good returns over the past 20 years, because there has been a structural change in the bond market as a result of the government’s policy of inflation-targeting. 

He says that although property should deliver attractive returns in future, you should not assume that the current high returns will continue. 

Although the returns from listed property have been good for 20 years, investors in this asset class can lose money, he says. Between 1983 and 1998, the real return from listed property was minus 7.8 percent a year. 

The local equity market should deliver better returns in future, but it is not possible to say when that will be, Tucker says. Short-term movements are extremely difficult to forecast, because they are driven more by sentiment than by fundamentals.

However, given that the global economic environment is improving, the recent period of low or no returns from equities has allowed the market to regain some value, he says.

Over the short term, you are unlikely to enjoy the high returns earned in 2009, 2010, 2012 and 2013, but equities should start to deliver 10 to 12 percent a year over the medium term, Tucker says. This should enable multi-asset funds to deliver a real return of four percent over the next five years, he says. 

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