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IMPASSIVE INVESTING


Casparus Treurnicht

Portfolio Manager

July 2020


Hindsight bias is a term used in psychology to explain the tendency of people to overestimate their ability to have predicted an outcome that could not possibly have been predicted beforehand.


Are you aware that for the five years ending 30 June 2020, 90.68% of all funds in the General Equity sector of South Africa under-performed the market (J203T: FTSE/JSE All Share Index Total Return)? This means that 11 out of 118 funds were able to outperform the market; investors thus stood a 9.32% chance of selecting one of these outperforming funds. And this data does not include funds that have closed down…usually due to a poor track record. Furthermore, it’s unlikely that investors would have remained invested in the same fund for the entire period. Investors very often elect to bank returns or cut their losses after a period of considerable volatility; emotions take the driver’s seat and investment decisions get tossed into the back seat!


Investors can manage expectations, reduce anxiety and avoid disappointment by understanding three aspects of fund selection:


  1. What return profile can be expected when looking at funds that outperform the market?

  2. How likely is it that you’d have selected currently performing funds beforehand (and remained invested)?

  3. How would I have done if I’d invested in a fund that just tracked the market (an index tracker)?

We address each of these below:


1. WHAT RETURN PROFILE CAN BE EXPECTED WHEN LOOKING AT FUNDS THAT OUTPERFORM THE MARKET?


The graphs below illustrate the four top-performing General Equity active funds (with a track record of more than ten years) relative to the J203T. As you can see, each of these funds outperformed the J203T at the end of the 5-year period.


Bear in mind that these graphs plot the relative performance of each fund versus the J203T (All Share Index); when the fund line is above the zero-percentage line, the fund is outperforming the market, when it goes below the zero line, it is under-performing the market.

You can see that at some stage each one of them under-performed the market. While it would be unreasonable to expect all of these funds to outperform all of the time, the inherent volatility must be considered. There have been multiple periods when all out-performance was given back. Would you, as an investor, have had the fortitude to have remained invested throughout this entire period?

2. WOULD YOU HAVE SELECTED THESE FUNDS 5 YEARS AGO BASED ON THE PREVIOUS 5 YEAR PERFORMANCE? (i.e. 10 years ago)

If we consider how these same funds performed in the preceding 5-year period - from 30 June 2010 to 30 June 2015. You’ll notice that two of the funds under-performed severely in this period. One fund experienced massive volatility, only achieving out-performance towards the end of the discrete period. Just one fund maintained consistent out-performance.


3. HOW WOULD I HAVE DONE IF I’D INVESTED IN A FUND THAT TRACKED THE MARKET?


We maintain that it remains extremely challenging for investors to predict which managers would outperform over a discrete period. While the stock market is the highest yielding investment over the longer term, it is not directly investable. By making use of a fund that tracks the performance of the market, you can capture these returns. While it is important to invest in a fund that charges a low fee, it is more important that the fund selected, and market performance is successfully aligned. Focusing your energy on what is predictable will give you better control over your investment choices and enable your financial wealth to compound at an optimal rate.

What we’ve learned:

  • Investors will always struggle to predict which funds will outperform over a particular period.

  • Indexation may be seen as a passive product, but it is not a passive investment decision.

  • Indexation is an active decision that leads to consistent performance that in turn results in the out-performance of the majority of active fund managers over almost any period.

  • Indexation is the rational choice when it comes to keeping your investment emotions in check.

  • Indexation is the rational choice when it comes to controlling investment costs.

In conclusion, a quote by Burton Malkiel:

“J.P. Morgan once had a friend who was so worried about his stock holdings that he could not sleep at night. The friend asked, 'What should I do about my stocks?' Morgan replied, 'Sell down to your sleeping point' Every investor must decide the trade-off he or she is willing to make between eating well and sleeping well. High investment rewards can only be achieved at the cost of substantial risk-taking. So what is your sleeping point? Finding the answer to this question is one of the most important investment steps you must take.”

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