While the dictionary definition of outperformance is simple, the complexity starts when we want to understand it in the context of our investments, as we are faced with so many things we can measure against – the market, inflation, the performance of peers, our goals, to name a few. Thandi Ngwane assists.
Say the average share on the Johannesburg Stock Exchange (the JSE) returns 10% over a year, inflation is 5% and your unit trust returns 7% (call this scenario 1). Has the unit trust outperformed?
Or consider scenario 2: The JSE returns -8% over a year, inflation is 5% again and your unit trust returns -3% in the same time period, i.e., you have made a loss. Has the unit trust outperformed this time, despite the loss?
And ponder scenario 3: The JSE returns 15% over the year, SA bonds return 2%, inflation is 10% and international shares return 20% in rands. You are invested in two unit trusts: one returns 17% and the other returns 13%. Has either outperformed?
Choosing a benchmark
Outperformance depends completely on your point of comparison (your benchmark). If inflation is the benchmark, the unit trusts in scenarios 1 and 3 all outperformed and the unit trust in scenario 2 underperformed by a hefty 8%. If the JSE market return is your benchmark, the unit trust in scenario 2 outperformed by 5%. If you were trying to beat international shares, even the 17% return of the unit trust in scenario 3 would have been under the mark by 3%.
Investment managers and the trustees of unit trusts are required to select an appropriate benchmark for each unit trust: it must match the unit trust’s investment objective and portfolio restrictions. This is intuitive: comparing a unit trust that is mostly invested in equities to the performance of bank savings isn’t appropriate, as the risks you take on with equities are much higher than with bank savings.
It is also useful to consider and set your own objective or benchmark return. A good, independent adviser will be able to help you with this. Generally, the higher the return that you aim for the greater risk of loss you need to take on. As you consider your objective, you can match it with the long-term returns of different categories of unit trusts and, most importantly, consider the riskiness of each, i.e., the ‘bumpiness of the ride’ that different kinds of unit trusts tend to experience.
Performance is not linear
Imagine that one of your investments returns 12% after a year of smooth growth, with a positive performance in every quarter.
Another also returns 12%, but only after losing 3% in the first quarter, then climbing 8%, losing 4% and then finally recovering to make up 12% over the year. Which has outperformed?
If you are simply assessing the performance of these two investments between their end points, they have delivered the same return. But if you had to sell the second investment at the wrong time, or if you lost confidence and sold it out of fear, your actual returns would have been a lot worse in the investment that was more up and down. Even if annual returns look the same, the ‘bumpiness of the ride’ can make a real difference to the actual returns achieved.
Outperformance in down markets
Because they reduce bumpiness (or volatility), all other things being equal, unit trusts that deliver all of their outperformance by keeping losses shallow in down markets should create more wealth over the long term for investors than managers with their outperformance in up cycles.
Forgive us some marketing: as at the end of September, dividing the full history of the Allan Gray Balanced Fund into months in which the market was up and those when it was down, all of its 4.8% outperformance since inception has been delivered in the average down month, and none in the average up month.
Unit trust factsheets include statistics on volatility, along with investment performance and maximum losses over a unit trust’s history. Factsheets are available via our website www.allangray.co.za or from our Client Service Centre.
How should you evaluate performance?
When you evaluate how your investments are performing, consider a few things before making any rash decisions:
- What does outperformance mean to you? Your needs are the most important measure of whether an investment is performing as it should.
- Remember to consider the risk that your investment has to take to achieve returns. Investment returns that fluctuate may not suit your temperament even if they go up over the long term.
- Is your investment outperforming a poor market, even though returns are currently negative? Markets go up and down and you should expect to occasionally get negative returns. The decisive factor should be whether your investments are working hard to preserve your capital.
- Evaluate performance through the market cycle. This means not just looking at the recent past, but look at your investment over a long enough timeframe to get a real sense of its performance throughup and down markets.