Think carefully before you make a move

If you have an uneasy feeling in the pit of your stomach regarding your investment returns over the last two years, you are not the only one.  the performance of the listed asset classes (in ZAR) over the last two years (until the 31st of October 2016).

Source:  Allan Gray “Research Tool”

Our experience is that most investors are overweight in local assets which had a torrid time lately.  Unfortunately, because of inappropriate switches, amongst other things, most investors’ funds have generated even worse returns than what the indexes have delivered.  These switches were often made during times of high volatility over short periods of time.  A well-known fund manager recently published an article which clearly shows that after a period of underperformance of their Balanced Fund relative to other funds, investors disinvested from the fund at the most inappropriate time.  Turn the clock a year on and although the fund has outperformed its peers, investors are only now starting to invest again and have missed out on these returns.  This behaviour of chasing short term performance is endemic to the investment industry and one of the biggest factors impacting investor returns.  Let me illustrate this behaviour at the hand of the following real life example:

On the 31st of October 2014 Mr X invested R 1 million in the following fund allocations:

Fund A                  =             R 300 000 (30% of his fund)
Fund B                  =             R 250 000 (25% of his fund)
Fund C                  =             R 200 000 (20% of his fund)
Fund D                  =             R 250 000 (25% of his fund)

Exactly 1 year later, on 31 October 2015, his portfolio looked as follows:

Fund A                  =             R 353 880 (Performance for the last 12 months = 17.96%)
Fund B                  =             R 234 125 (Performance for the last 12 months = -6.35%)
Fund C                  =             R 192 460 (Performance for the last 12 months = -3.77%)
Fund D                  =             R 328 000 (Performance for the last 12 months = 31.20%)

His total fund value amounted to R 1 108 465 which represents a total return of 10.85%

During the annual review of his portfolio, the fund allocation and performance is considered and a decision should be made for the future.  Usually, there are 3 options that can be implemented.

Option 1:  Get rid of the poor performing funds by disinvesting from it and then allocate the proceeds into the funds that performed well during the past 12 months.  For illustration purposes, let’s assume that we take all the money in fund B and add this to fund A and transfer all the money in fund C to fund D.

Value on the 31st of October 2016 (two years after inception):

Fund A                  =             R 658 095 (Performance for the last 12 months = 11.92%)
Fund D                  =             R 486 474 (Performance for the last 12 months = -6.53%)

For the last 12 months, his investment grew with 3.26% (Fund Value = R 1 144 569).  His average return for the last 2 years is 6.98% p.a.

Option 2:  No changes to the portfolio

Fund A                  =             R396 062 (Performance for the last 12 months = 11.92%)
Fund B                  =             R376 910 (Performance for the last 12 months = 60.99%)
Fund C                  =             R193 673 (Performance for the last 12 months = 0.63%)
Fund D                  =             R306 582 (Performance for the last 12 months = -6.53%)

For the last 12 months, his investment grew with 14.86% (Fund Value = R 1 273 227).  His average return for the last 2 years is 12.84% p.a.

Option 3:  Rebalance the investment in line with the original fund allocations.  This would mean that we invest MORE into the funds that performed negatively and withdraw out of the funds that performed well (this is the opposite to the first option).

Fund A                  =             R372 178 (Performance for the last 12 months = 11.92%)
Fund B                  =             R446 129 (Performance for the last 12 months = 60.99%)
Fund C                  =             R223 090 (Performance for the last 12 months = 0.63%)
Fund D                  =             R259 021 (Performance for the last 12 months = -6.53%)

For the last 12 months, his investment grew with 17.32% (Fund Value = R 1 300 418).  His average return for the last 2 years is 14.04% p.a.

Although the above example is probably a bit of an over simplification and the answer on what route to follow over a 2-year period would not always be option 3, the principles in the above example are still valid and there are some important points to take notice of:

  • The cost of the behaviour gap, is by far the biggest factor (besides fund fees, quality of the fund manager, etc.) influencing investor returns. This is an invisible fee that is seldom discussed in the mainstream media and financial publications.  In the example above, the cost of this behaviour was around 6% in only two years.  If this behaviour was repeated over longer periods of time, the investor could end up in a far worse situation.
  • Never adjust your portfolio based on short term historical performances. Short term performances really are a very poor indicator of future returns.  If you catch your advisor, or yourself, acting reactively, it is probably time to take a thorough look at the investment process you follow and your emotional ability to handle the volatility that comes with investing in the markets.  A lack of emotional stability can cost you immensely.
  • The rebalancing of your portfolio from time to time is very important for various reasons. The biggest of these is the fact that because the best performing funds (i.e. aggressive funds which carry more risk) automatically becomes a bigger portion of your total portfolio, the risk of your total portfolio also increases.  With risk, I specifically refer to bigger than expected drawdowns.
  • The rebalancing of portfolios can have capital gains consequences (depending on which investment vehicle you use), but it is seldom worth the effort NOT to rebalance just to avoid capital gains tax. Remember, by not rebalancing the potential capital gain implications only becomes bigger over time and must be paid someday, whilst the risk of your portfolio gradually increases due to aggressive funds becoming a bigger proportion of your portfolio.  For example, in Option 3 mentioned above Fund B makes up 34% of your allocation after year one (based on the good returns of the fund) while the original allocation was only 25%.

Try and keep your cool during the next few months, they don’t call it “silly season” for nothing.  I have a suspicion that the urge to make impulsive decisions (and here I’m not referring to burning your Springbok jersey) is going to be tempting.

*Andró Griessel is a certified financial planner and the managing director of ProVérte Wealth & Risk Management.  Follow him on Twitter @Andro720911.  He writes twice a month for Sake24

Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth Management & Risk Management is an authorised financial service provider with FSP no. 5966.