Unit trusts navigating volatility in 2022

Andrew Davison, Head of Advice at Old Mutual Corporate Consultants

Accepting all the risks that come with investing is essential to build savings that outperform inflation. Trustee boards shoulder great responsibility managing money on behalf of members and are required to be very thorough when making investment decisions

The job of any investor is to stay calm in the storm and seek out the asset managers that have a proven track record in delivering good, inflation-beating returns over the long term. This is according to Andrew Davison, Head of Advice at Old Mutual Corporate Consultants who says that the first six months of 2022 have been nothing short of a rollercoaster, including Russia’s invasion of Ukraine and its effects on the global economy, lockdowns in China, supply chain constraints, oil price increases and rampant inflation in key markets.

Taking a look at the 172 equity unit trusts available in South Africa, including active and passive trackers, there is a wide disparity in performance over the past six months. “This is before even considering the local environment in South Africa where incessant load shedding is squeezing an economy already reeling from global pressures. R100 invested in the FTSE/JSE All Share Index at the end of 2021 would have gone on a wild ride, being worth only R91,70 by the end of June,” he says.

However, when analysing performance over a decade, there certainly are managers that have earned their stripes. It is crucial for investors to master the skill of seeking out these long-term performers amidst the noise of short-term chaos.

UNIT TRUSTS NAVIGATING VOLATILITY IN 2022

It has been a turbulent 2022 for investors. Although many investors and asset managers started the year in ebullient mood, sentiment quickly soured. Russia’s invasion of Ukraine, the effects of supply chain disruptions as the globe emerged from Covid-related lockdowns and renewed hard lockdowns in China. Then we saw surging energy prices (partially due to Russia’s invasion but also due to supply risks inherent in the transition to cleaner energy sources) as well as rising food prices and prices in general are fuelling runaway inflation in major economies like the US, UK and Europe. The result is that central banks have been raising interest rates around the world, including here in South Africa. On top of all of this, South Africans have a stuttering economy and load shedding to contend with.

As a result, each R100 invested in the FTSE/JSE All Share index at the end of 2021 has been blown around like a R100 note in the Cape south-easter as shown in Graph 1 and ended the half year with a loss of over 8%.

Graph 1

A period like this can be challenging for investors, it’s worthwhile taking time to understand how different types of equity portfolios behave and how well they are able to navigate the uncertainty. It’s also important to assess whether the portfolio one is invested in is doing what “it says on the tin”.

Unit trusts are utilised by many investors, both in their individual capacities as well as through retirement funds. The large range of options and the extensive data available on unit trust returns enable us to gain valuable insights on asset managers and their portfolios.

There are 172 equity unit trusts available to investors in the SA General Equity sector with at least a six-month history. This is a daunting list and is made up of mostly active managers trying to beat the index by adding so called ‘alpha’ as well as a handful of tracker funds aiming to replicate a particular index as closely as possible at low cost and also a few hybrid funds or so-called smart beta funds that use quantitative methods to capture alpha at ‘medium’ cost.

In reality it’s difficult to be truly passive in investing as even a choice to invest in a tracker portfolio involves a key decision of which index to track, a task made more difficult by the expansion in the number of indices available over the last decade or so.

In terms of active managers, it’s interesting to assess who’s been able to outperform the various indices, especially as active managers often claim that a key advantage they offer clients is their ability to limit volatility and downside whereas the index trackers just fall with the index during downturns. The 2022 year to date thus offers a useful test. Note that this is a very short period with vastly different fortunes for different sectors and stocks. Take care: it offers useful insights but should not be used in isolation to make decisions about individual unit trusts or their managers.

Graph 2 shows the returns of the top half (best performing) of all SA General Equity unit trusts during the first half of 2022. Each green bar is a different actively-managed unit trust and each orange bar is a rules-based or tracker unit trust.

It’s interesting that only two out of 172 unit trusts have outperformed all the benchmark indices after fees. Although it isn’t necessarily fair to expect an active manager to outperform all indices, this is certainly indicative of a lot of skill or a lot of luck or both.

Only 12 of the 172 unit trusts delivered a positive return in 2022, with three of those being tracker funds that track the Dividend plus index, which is the only index to deliver a positive return. These three tracker funds did a reasonable job of implementing their tracking mandates, although some better than others. The ability to track the index closely is a key criterion in selecting a tracker fund; not just the lowest fee.

The Capped SWIX index is a more popular choice with five unit trusts tracking this index at varying levels of proximity.

Graph 2

Source: Morningstar, Refinitiv, Old Mutual

The bottom half of the SA General Equity performers is shown in Graph 3. Here, we start to get a sense of just how tough the six-month period has been. There certainly does not seem to be much evidence of these active managers being able to navigate the volatility of the environment better than the passive trackers.

The dispersion of returns, the difference between the best and worst performers, is 23%. This is a big difference over a short period but is not unexpected during a period of such high volatility.

There is one tracker manager that appears to be in no man’s land, far from any index. In fact the manager has ‘succeeded’ in substantially outperforming its index benchmark.

The trackers tracking the All Share index are likely to have the longest track records and hence the most experience in index-tracking. Here again, there is dispersion in their tracking errors.

The tail end of the unit trusts has some extremely poor performers. Among these are some high quality names, indicating that even managers with long track records of outperformance can have periods of weak performance. Some of these unit trusts are managed by managers who pay no attention to any benchmark. This is also important for investors in these funds to understand. Taking a contrarian view will mean that these funds should not be compared too closely to any index or even other managers, especially over short periods. It is very important not to make any rash decisions based on short term performance.

Graph 3

Source: Morningstar, Refinitiv, Old Mutual

Given the importance of focusing on the long term when evaluating and selecting asset managers, the results in Graph 4 show the 10-year track records of those unit trusts who have stood the test of time. There are 67 such unit trusts implying that 105 of the current unit trusts in this sector have a track record of under 10 years.

This is a long enough period for pedigree to shine through and the nine managers that have trounced all of the indices have a justifiable claim that their returns are not just the result of luck. Two of these managers have delivered truly exceptional returns. Both of these managers are also in the top quartile during 2022. The ability to select, and stick with, the best active managers can result in long-term returns that are well ahead of the benchmark even after the higher active fees.

In terms of the benchmark trackers, the unit trusts have mostly been tracking the All Share over this period. The tracking ability has been mixed with some managers tracking very closely (a reminder that these returns are net of fees so some lag relative to the index is expected) and others showing a larger tracking error.

Given the imperative of beating inflation in order to preserve the spending power of capital, this graph also shows CPI. The three funds that failed to beat inflation over ten years need to do some reflection about their ability to meet their clients’ needs.

Graph 4

Source: Morningstar, Refinitiv, Old Mutual

Investing or, viewed differently, delayed consumption, is essential to build savings. This is not just true for retirement but for other specific goals, big purchases and also to provide for emergencies and other unforeseen expenses that may arise when one is least prepared. There are many excellent unit trusts available to South Africans and this article only covers one particular sector – South African equity.

Whether you are an individual selecting a unit trust or a member of a retirement fund exercising your investment choice, some practical tips will assist you to make a sound choice and reap the rewards in terms of superior returns.

Be clear about your objectives and your time horizon.
Understand the type of fund you’re choosing and what it aims to deliver to investors.
Both active funds as well as tracker funds have merits so be aware of what you’re choosing and be realistic about how it is likely to perform.
If you’re choosing a tracker fund, important decisions include which index the fund is tracking, how that index is likely to perform and the manager’s tracking ability (as measured by tracking error).
If you’re investing in an active fund, understand how they aim to outperform and check their track record and consistency of returns over the long term. Be aware that active management entails performing differently to the benchmark and periods of underperformance are part of the package along with periods of outperformance. Staying the course is more important than trying to always be in the prevailing top performer, because even the best funds will experience challenging times.
Although not the only factor, pay attention to the level of fees charged and whether they are appropriate to the type of management e.g. active or tracker and are competitive in relation to similar funds.

ENDS

Produced by Old Mutual Corporate Consultants. For more information contact your Old Mutual Corporate Consultant or visit ,www.oldmutual.co.za/OMCC, ,and visit ,www.oldmutual.co.za/mindspace, ,for more articles on a range of relevant topics.

Old Mutual Corporate Consultants a division of Fairbairn Consult, Registration Number 2015/036102/07, a licensed FSP and a member of the Old Mutual Group.

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