It is little wonder that general equity funds such as Allan Gray, Nedgroup Investments Rainmaker, Oasis and Prudential attract investor money in such significant quantities. They have performed better on average and on a more sustainable basis than other general equity funds.
But what many investors do not realise is that the risk taken by the managers of these funds is a lot less than that taken by fund managers such as Stanlib, whose equity funds are at or near the bottom of the performance tables.
This is one of the more interesting conclusions reached in research undertaken by PlexCrown Fund Ratings and published in detail in Personal Finance today.
In the accompanying table, the following details are provided for the seven-year period to June 30, 2010, for general equity funds with at least a seven-year history:
- PlexCrown's new downside risk ratings;
- PlexCrown's crown ratings, which use various factors, including performance, consistency of performance and various risk ratings, to classify funds on a sliding scale from one to five PlexCrowns, with the better funds having more crowns; and
- The average annual performance of each fund.
The table shows that one of the top-performing funds, the Nedgroup Investments Rainmaker Fund, has |a risk rating of 5.8, whereas the Stanlib SA Equity fund has a risk rating of 9.6. The average risk rating of the funds in the general equity category is 7.5.
What this means is that your chances of losing money are significantly higher if you invest in |the Stanlib fund than in the Nedgroup fund.
The question you (and your investment adviser) need to ask is whether you would have invested in Stanlib SA Equity Fund if you knew the risk of losing money was greater than the average, even if the fund enjoyed a higher return.
The problem is that just as many people do not realise there is a |tendency towards low risk by the best performers, so they do not understand the tendency towards high risk at the low end of the performance table. This is mainly because the industry rates risk |by asset-class category, instead of rating funds individually for risk.
PlexCrown director Ryk de Klerk correctly says it is wrong and misleading to generalise and advocate that because funds fall in the same category they should be given the same risk level.
He says allowing funds to use a risk-rating scale based on categorising risk by asset class allows funds to hide from investors some extraordinary risks they may take.
The Association for Savings & Investment SA (Asisa) is correct in saying that asset-class risk categorisation should not be scrapped but it should come with qualifications.
However, other more important risk factors, such as downside risk, should be declared individually by funds and by the industry on a comparative basis.
This is not only important for investors, so that they can understand what is happening, but also for financial advisers, so that they can give proper advice as demanded by the Financial Advisory and Intermediary Services (FAIS) Act.
De Klerk also says that the assessment of risk is not a once-off exercise, because risk changes, for example as fund managers are replaced, investment philosophies change, investment management companies amalgamate, or when funds become large and unwieldy, causing fund managers to lose their edge on their peers.
This means you must take account of the longer-term relative risk of a fund against other funds in the same peer group as well as the risk trend of a fund.
You can track a fund's downside risk over time using the PlexCrown risk ratings, which allow you to compare a fund to the average of its category and against other funds. This will indicate whether something has changed or is changing in the risk profile of a fund.
Two of the more interesting funds worth tracking using the PlexCrown methodology are the low-performing Stanlib Equity Fund and the fourth-placed Absa General Equity Fund. The changes in the downside risk of the two funds show two things: higher risk tends to equal lower returns and by lowering risks funds can achieve better returns.
The Absa fund has been taking less and less risk measured against the general equity sector average, and in doing so its performance has improved, whereas the Stanlib fund has taken some high-risk bets that initially paid off, lulling investors into a false sense of security.
Graphs show how dramatically the Stanlib fund downside risk has increased against the general equity fund average and how the Absa fund has moved in the opposite direction.
But a warning: as the data in the table shows, you cannot only use downside risk of a fund to reach |an investment decision.
Asisa must move quickly to ensure its members publish their downside risk on their fund fact sheets and that Asisa also publishes comparative tables.
The same should apply to all comparative performance tables, including those used by the retirement fund industry. Retirement fund trustees should simply tell their asset managers to provide the information.
If the industry does not move quickly, the Financial Services Board should by regulation make proper risk disclosure obligatory. It is also in the best interests of financial advisers in meeting their FAIS obligations that they also demand the information from the industry.
Asisa is in favour of collective investment schemes providing investors with more accurate risk assessments of their funds on the fund fact sheets.
Leon Campher, Asisa's chief executive, admits the industry association's compartmentalised risk table does not make it possible to accurately assess the complete risk profiles of individual funds.
However, he says, the table is an internationally accepted way of providing a high-level overview of where fund categories are positioned in terms of risk.
Campher says internationally there is a review under way of how risk should be shown to investors, and the industry would prefer to await the outcome of the review to implement international best practice in South Africa.
As the South African sponsor of the Global Investment Performance Standards (GIPS), Asisa has, over the past 18 months, been part of the global debate on measuring and disclosing risk.
"Resolution has finally been achieved and work can now commence on drafting global standards on this," Campher says.
In the meantime, he says, a disclaimer has been added to its compartmentalised risk table to ensure you are not misled.
The disclaimer reads that the table is a "broad, generic indicator of the risk profile of the different types of collective investment scheme funds. Please note that higher risk is not necessarily an indicator of higher return. It is important for investors and advisers to determine the risk-return profile of a specific portfolio and compare this with other portfolios in the category."
Campher says a meaningful comparison of risk can only be achieved when comparing like with like.
For example, you should compare the risk and return profile of a domestic general equity fund with that of another domestic general equity fund.
He says there are numerous different risk and return methodologies provided by statistics providers and asset consultants. These vary from simple measures of volatility to the measurement of downside risk.
Campher says neither you nor your adviser should rely on any one indicator, but should use the various tests of risk in conjunction with each other. You also need to ensure that you understand what a particular methodology attempts to indicate.
He says the main problem at the moment is not the existence of the various risk calculations, but that their availability to investors is limited, because the data providers tend to charge for the information.
However, most financial advisers should be able to provide you with the information.
Campher says risk ratings should become more easily accessible to investors. This includes the publication of risk-return profiles on fund fact sheets, which are freely available to investors.