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Thursday, April 1, 2010
Make your peace

Short-term ranking.

“When it comes to unit-trust performance we don’t have to look further than the weekend paper to get an idea about which unit trusts are doing well and which ones are not,” comments Mark Seymour of Alphen Asset Management. “As clients, advisors and multi-managers the natural response is a feeling of deep satisfaction when our chosen unit trust is high up in the rankings and a gut wrenching sickness when it plunges down the rankings.
“But if we let this type of emotional response influence our choice of unit trust, there is a high potential of destroying capital.”
Writing in a recent Alphen Angle, the firm’s client newsletter, Mr Seymour explains why.

Rankings fluctuate

Unfortunately in the real world even top asset managers experience fluctuating relative returns. “In the first graph I have plotted the relative rankings of both the Sanlam Value Fund and the Allan Gray Equity Fund versus all other equity funds in the value, growth and general equity sectors. While both these funds have delivered top quartile performance, over the long-term their 12 month rankings (measured at the end of each month) they have both ranged in between the top and bottom quartiles. The gray line represents the number of funds in the three (value, growth and general) sectors over time. The red and blue lines represent the relative rankings these two funds have experienced over time.
Graph 1. 12 month rankings for the Allan Gray Equity and Sanlam Value funds Source: Morningstar and Alphen Multi-Management

Switching destroys value

Referring to the two unit trusts depicted in the graph, if a client had followed a system whereby he or she switched to the higher ranked unit trust as a result of the other fund’s relative underperformance, there were four potential occasions where manager changes would have been implemented (see second graph)
Graph 2. Switching unit trusts based on 12 month ranking Source: Morningstar and Alphen Multi-Management

Calculating the returns based on a switching strategy versus a buy and hold strategy (50% split between both funds) highlights the danger of switching unit trusts based on short-term rankings (see graph 3). From the end of June 2002 through to the end of December 2009, the buy and hold strategy would have delivered a 380% return whereas the switching strategy would have delivered 241% (a difference of 139%).
Graph 3. Buy & hold strategy returns vs. the switching strategy returns Source: Morningstar & Alphen Multi-Management

Comments Mr Seymour, “Make peace with the fact that all managers will experience fluctuating relative returns and instead of expending energy on concerns relating to relative performance one should spend the time getting to know the asset manager’s processes and whether or not this process remains intact.”


Copyright © Insurance Times and Investments® Vol:23.4 1st April, 2010
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