The Truth About Unit Trusts

The Truth About Unit Trusts

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Don’t invest in cash because inflation will eat into your returns. Diversify your investments as much as possible. Keep a close eye on daily stock market prices. A deep analysis of unit trust data undertaken by Sanlam Investment Management (SIM) shows that this sage investment advice may not be as sound as popularly believed.

Many of the investing maxims we’re used to hearing should now be considered myth. Much investing takes place on the basis of sentiment, speculation and misguided assumptions. But research over the long term can now dispel these assumptions – to the benefit of the investor. Here are five myths of unit trust investing.

Myth 1: You shouldn’t invest in cash because inflation will erode returns.

Statistics show that cash has outperformed inflation over most decades since the mid-1950s. As long as the Reserve Bank keeps positive real interest rates, cash will provide above-inflation returns. This is also currently the case: consumer inflation rose 5,3% year-on-year in August, while the repo rate today stands at 5,5%.

Another surprising result from SIM’s research has shown that cash has outperformed bonds over the period since 1957. Had an investor put R1 into cash, he would have accumulated R291,12 by the beginning of 2011. Bonds would have returned R237,54 over the same period.

However, investing in cash comes with an opportunity cost as opposed to investing in equities. Since 1957, a R1 investment would have been worth R5 767 by the start of 2011, had it been placed in equities. Investors in 2008 bailed out of the stock market after it crashed – only to lock in their losses and invest in far lower yielding cash. This could prove to be extremely costly if maintained over the long term.

Myth 2: When stock markets become highly volatile, run for shelter.

Most investors disinvest in equities during a market crash. However, there is no consistent correlation between volatility and stock market returns. Rather, invest based on fundamental company valuation measures.

SIM has followed the value investment strategy – buying shares when they are unpopular, and selling them when they become popular. For example, had you bought the All Share Index in 2003, when it was highly unpopular, you would have enjoyed attractive returns. The value strategy has also offered the best returns, based on analysis since 1997. Market sensitive stocks, on the other hand (those shares that move with the market) have been the second worst performers over the past 17 years.

Myth 3: I know my risk tolerance.

Chances are your risk tolerance changes when markets do an about-face. Investors regularly fall into the trap of buying assets when they are expensive, and selling when they are cheap. To overcome this, stick to a time horizon and do not deviate from the investment plan.

Also, know what can reasonably be expected from each asset class. Data collected over the past century shows one can potentially expect a 7% long-term real return from local equities, 3% from local bonds and 2% from cash – if you stay invested for a minimum of ten years. Global equities could deliver 6% above inflation and global bonds 2%. SIM’s own research shows investing in its equity-dominated Aggressive Fund would return a third more over ten years than opting for a Conservative Fund.

One compelling solution to overcome emotional investing is to invest in a well-matched multi-asset class fund, and let it do the hard work for you – dispassionately.

Myth 4: If you invest with an award-winning fund manager, you will get the best performance in future.

There are two pitfalls with this thinking. For one, the top performer rarely remains at the top for long. And investors who select funds using this criteria run the risk of falling prey to short-term bias. Ideally, annualised performance over five to ten years will give you a more reliable indication of what to expect from the manager or fund. Investors are likely to be better served by a manager who has consistently delivered benchmark-beating returns, because that is far more likely to be repeated.

Myth 5: The more diversified your investments, the more likely you are to achieve consistent, superior returns.

The truth can be opposite: diversifying your portfolio is a complex process, and at some point diversification can destroy value. What’s the limit before value is lost? Research shows a portfolio with more than four funds fails to add value.

There are two alternatives to investors. Either build up a good understanding of the complexities and risks involved in building a portfolio. Or simplify the process by investing in a multi-asset class, balanced fund. It should be managed by professionals who have the skills to get the most out of diversifying across asset classes, and whose investment styles can adapt during different market conditions.

Candice Paine
Candice Paine is the Head of Retail at Sanlam Investment Management. Candice holds a BCom (Hons) in Financial Analysis and Portfolio Management from the University of Cape Town and is a Chartered Financial Analyst.