The story of the duck and the scorpion illustrates how we tend to act in a certain way, even if it’s not in our best interest.
The duck hesitantly offered to help the scorpion to safety after he was stranded in a flood. Shortly before reaching the shore, however, the scorpion stung the duck, which eventually led to the death of both of them. Although the scorpion knew that his actions would kill them both, he found it too difficult not to give in to his natural instincts.
Investment figures published monthly for both shares and unit trust funds can place investors in the scorpion’s position. It’s in our nature to want to choose current winners for our portfolio, but, historically, it’s been proved that this could land you in very deep waters.
Let’s use local unit trusts as an example. Investors can limit their research to funds that performed the best in the previous year, but, in my opinion, this approach may be more poisonous than the scorpion’s sting.
If you invested in last year’s five best-performing South African equity general funds, your investment would have grown by an average of 33.37%, whereas the sector on average returned just more than 3% over the same period and the FTSE/JSE All Share Index grew by a mere 2.6%.
Most of the top five funds were, in the main, exposed to resource-based shares, but the return shows that it was possible to achieve excellent growth for those who were willing to take the risk in a relatively difficult investment environment.
The five weakest-performing funds would have treated you much worse: you would have lost more than 10% of your capital.
True to their nature, at the beginning of this year most investors would have chosen the five best-performing funds of the previous year, simply because these funds delivered amazing returns in 2016.
Unfortunately, managing risk and investments isn’t quite that simple, because, to October 17 this year, the top five performers of 2016 would not have provided you with even half the returns of the equity general sub-category, or the JSE’s returns.
An even more interesting fact emerges when you look at the five worst-performing funds of 2016. Not only have these five funds so far performed better over the same period, but they have also delivered double the returns of the five best-performing funds.
I don’t recommend that you choose the five worst-performing unit trust funds (or shares) for your portfolio each year. I also don’t recommend that you limit your choices to the funds that did well in the past.
Always take the following criteria into account when choosing funds: the underlying costs; the quality and history of the management team; the fund managers’ ability to deliver constant (not limited to a one-year period) above-average risk-adjusted returns; and the size (in rand value) of the underlying funds. These four factors are far more important investment aids than basing your choice on how funds performed in the past.
When it comes to choosing funds, it is always advisable to consult an investment professional to ensure that your natural instincts don’t get the better of you, leaving you to drown, because you ended up at the wrong end of the scorpion’s sting.
Schalk Louw is a portfolio manager at PSG Wealth Old Oak.