Equity reports

Choose equity unit trust funds for their strengths

Those of you who follow my reports on a regular basis will know that I love to compare and analyse stocks according to different ratios globally in an attempt to identify the best of the best.  I have also pointed out that there isn’t necessarily only one right answer when it comes to investment ratios.

The best way to explain what I mean by this, is to use two fund managers who practiced roughly at the same time, John Neff and Peter Lynch, as examples. Both of them were very successful in the active management of their clients’ capital and both invested strictly according to specific criteria. The main difference between them boiled down to the valuation methods chosen by each.

Neff was a value investor who focused especially on companies that traded at low price earnings ratios (P/E) and high dividend yields. He sold when the fundamental value of the share declined and/or when price targets were reached.

Lynch on the other hand, was a growth investor who preferred to buy during cyclical recoveries. He would start by making a small investment and then invest more and more as conditions improved and prices increased.

Why all this detail? I simply want to point out to investors that different ratios outperform benchmarks at different times. Investors who were lucky enough to be invested in the funds of both Neff and Lynch, would be the happiest of investors today. Both funds performed amazingly well, but during times where Lynch’s fund would have struggled somewhat, Neff’s fund performed better, which would have resulted in stabilised growth of investors’ returns.

Few South African investors seem to realise that we have similar tools to our disposal. Some of you may want to stop reading at this point, thinking that active management has delivered such a poor performance these last few years that one really doesn’t have to look much further than passively managed funds. Sure, half of these thoughts may be true, but the other half not quite as much. The fact is that we still have brilliant fund managers in South Africa who manage to outperform their benchmarks on a regular basis.

I analysed the data of all SA General Equity Unit Trust Funds by not only looking at the usual risk vs. reward ratios, but also how regularly these funds managed to outperform the FTSE/JSE All Share Index (JSE), for example. In other words, even though fund A might have managed to marginally outperform fund B over the last five years, fund B could still earn a higher rating than fund A. The reason being that if fund B could manage to outperform the JSE 80% of the months in question, while fund A could only manage to do so 30% of the time, investors could potentially earn better returns by remaining invested in fund B over time.

After analysing all of these funds, I selected only the top 15 funds with a total value of R1 billion or more to further my analysis. I have referred to factor investments in several of my writings in the past (investing according to certain themes). With this in mind, Neff (value) and Lynch’s (growth) methods can also be seen as two different investment themes. My personal preferences are value, quality and momentum shares.

Value investing is focused on shares with a higher earnings yield, lower price to book ratio and lower enterprise value (EV) to earnings before interest, tax, depreciation and amortisation (EBITDA) and enterprise value to EBITDA ratio (EV/EBITDA).

Quality shares are valued based on strong returns on equity (ROE) and the lowest possible EV to free cashflow ratio, while low volatility investing focuses more on shares with the lowest possible volatility ratios.

Momentum investing, focuses on shares with a strong increase in price, while avoiding the purchase of shares with declining value.

Over the last five years, several passive investment companies have established exchange traded funds (ETFs) which only contain shares with either value, quality or momentum characteristics.   I took the 15 abovementioned funds and individually identified each according to the greatest correlation with either value shares, quality shares and momentum shares. Three funds remained:

  • Fairtree Equity Prescient (value)
  • Investec Equity (momentum)
  • Marriott Dividend Growth Fund (quality)

Please note that I am not saying that Fairtree Capital, for example, should be labelled as value investors. Out of the 15 funds I analysed, they simply had the highest correlation with value.

Finally, I tested my findings by analysing the performance of a hypothetical investment in all three of these funds five years ago to date and the results were stunning.

Graph 1: Three equity funds with the best factors vs. FTSE/JSE All Share Index (source: Profile Data)

The JSE would have delivered returns of 33% (5.84%/annum) over the last five years (up to 17 May 2019). An investment in these three funds, however, would have delivered a return of 41% (7.06%/annum) over the same period. But it gets even more interesting. At a volatility ratio of 12.77%, these three funds combined were 10% less volatile than the JSE. The JSE’s worst performing week resulted in a 15% decline during this five-year period, while the combination of these three funds would have declined by only 13% during the same week. In other words, you would have earned higher returns at lower risk. The main reason for this can probably be attributed to the fact that none of these funds necessarily performed extremely well or poor at the same time, but rather that their respective performances complemented each other over time.

I would like to leave investors with a final thought: you would never compile a cricket team that consists of only bowlers in the same way that you would never compile a rugby team that consists of only front row players. Why would you want to approach the compilation of your investment portfolio any differently?

The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice.  This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.


Schalk Louw
As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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