When selling, what about capital gains tax?

In a recent article1 we made the point that while investors are encouraged to remain invested through the cycle, there are several warning signals that should trigger the re-evaluation of their investment in consultation with their financial advisor. The article generated much interest, with advisors identifying the following additional triggers:

Significant cashflows

Significant cashflows in either direction over a short period of time may impact a portfolio manager’s ability to implement his investment philosophy. Monitoring cashflows is therefore important. In this regard, it is also important to understand how concentrated the ‘ownership’ of the fund is, as a fund with a few large investors could be materially impacted should one or more decide to exit.

Assets under management

Certain investment philosophies’ ability to deliver outperformance reduces as assets under management grow and portfolios become unwieldy. It is crucial that the asset manager has the discipline to close to new investments and not succumb to greed.

Offshore capability

With managers now able to invest up to 30% offshore and a further 10% to Africa ex-South Africa (in respect of Regulation 28-compliant funds and funds classified by ASISA as South African portfolios2) it is essential that the managers demonstrate excellent, fully integrated investment capabilities, with local and offshore assets managed holistically. While some managers may outsource the offshore holdings in their South African portfolio, we believe it vital they are managed with full oversight by the South African fund’s portfolio manager(s), rather than as a bolt-on portfolio of vanilla assets benchmarked to a global index. Bolt-on, at best, does not enhance the risk/return tradeoff and at worst leads to unintended positions within the fund.

1 Viewpoint: When to sell? – September 2019.

2 ASISA Standard on Fund Classifi cation for South African Regulated Collective Investment Scheme Portfolios, 30.10.18.

The impact of capital gains tax (CGT), often overlooked

For discretionary investors, even if a warning signal has triggered, a further consideration is the early payment of CGT when making portfolio changes. Or is it? While often considered, the CGT impact is seldom quantified. However, this is an important exercise because when an investor disinvests intra-term and pays CGT there is the compounding opportunity cost of the tax paid. Simply put, an investor in the maximum marginal tax bracket who realises a capital gain of a R100 000 pays CGT of R18 000 (if he has already used his annual capital gains exclusion of R40 000). The opportunity cost to the investor is then the difference between the future growth on the full R100 000 (if he did not realise the investment) versus the growth on only R82 000. This opportunity cost is often missed in the investment planning process because the CGT on a portfolio rebalance is generally paid later in the year, and often from an investor’s other liquid assets.

 

Quantifying the CGT cost of portfolio changes

Now that we understand that the early payment of CGT may carry an opportunity cost, we have tried to answer the following question; “If an investor switches out of fund A and into fund B at some point during their investment term, what additional return is required from fund B to compensate the investor for the early payment of CGT?”

 

The answer to this question is not straightforward and depends on multiple factors, which include the returns and profile thereof delivered by fund A and B, the investor’s investment time horizon and at which point in the investment time horizon the investor decides to switch.

 

As an example, let’s compare the experience of two investors, Jack and Jill who invest a similar amount in fund A at the same time, and have an investment time horizon of 10 years. Fund A delivers a consistent return of 10% p.a. and Jack remains invested for the full 10 years, at which time he disinvests and pays his CGT liability. Jill, on the other hand, identifies one of the triggers detailed above and decides to switch out of fund A after 5 years. After paying CGT, Jill invests the remainder of her proceeds into fund B. Table 1 sets out the excess return per annum that fund B must deliver over the following five years so that Jill has the same fund value as Jack at the end of the 10-year term.

 

Table 1: Excess return required from fund B

The table above shows that, for an annual return of 10% p.a. from fund A, fund B needs to produce an additional 0.60% p.a. so that Jack and Jill finish on the same fund value after 10 years. This difference in return represents the opportunity cost of paying CGT after 5 years.

 

Fairly intuitively, our analysis indicates that:

• The required additional return from fund B increases as the return from fund A increases (as seen in the table)

• The longer the investment time horizon the greater the additional return required from fund B (e.g. doubling the investment term to 20 years increases the excess return required on fund B from 0.60% p.a. to 0.81% p.a.)

• The earlier into the investment time horizon you switch, the lower the additional return required from fund B and vice versa

Conclusion

The CGT impact of making changes to an investment portfolio should be carefully considered and quantified. The CGT impact can set a portfolio back and should therefore be evaluated against the expected benefit of the portfolio change. Given the multiple factors that will affect this decision, we strongly recommend that you consult with a qualified financial advisor and seek expert tax advice, as required.

 

For longer-term, higher marginal tax-paying investors it may prove beneficial to hold their underlying local investments in the Investec IMS Access sinking fund policy and for offshore investments in the Investec GlobalSelect Access sinking fund policy, as they will benefit from the lower CGT effective rate of 12% (for maximum marginal taxpaying investors).

Important information

All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). A feeder fund is a fund that, apart from assets in liquid form, consists solely of units in a single fund of a collective investment scheme which levies its own charges which could then result in a higher fee structure for the feeder fund. The fund is a sub-fund in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act.

This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Issued by Investec Asset Management, September 2019.

Focus on the Facts

I am tired as an investor. I am tired as an individual. I know that I am not alone. On the investment side, Darryl Hannington, Anchor’s head of portfolio management, spoke to equity fatigue and the various options available to investors in his article entitled, Invest(ing) in the other 99% published in the 3Q19 Navigator. Obviously, all the facts, figures and suggestions he made, makes sense. However, sometimes, as human beings, we might not necessarily.

In my previous article for the Navigator entitled Three money memories, I spoke about how financial behaviour tends to be more emotional than rational and that our financial behaviour, as with the rest of our actions, is a deep-rooted expression of our internal psychology.

 

The problem, though, is that, as human beings, there are numerous behavioural biases which impede our ability to reason if we don’t understand these inclinations and make a conscious effort to work around them. In this note, I want to talk about one of the options available to us as individuals to manage our mental health and, as a consequence, our financial health.

 

We are tired because we are constantly being bombarded by a seemingly never- ending stream of negative news. And, unfortunately, we are hard-wired on an evolutionary level to focus more on the bad news than (admittedly, the harder-to-find) good news. This is a psychological phenomenon known as the negativity bias.

 

A couple of years ago, I read a book by Rick Hanson, a neuroscientist and psychologist, called Buddha’s Brain. In this book, he simply explains our focus on negativity. Our ancestors needed to be alert to danger because it was a matter of life or death for them. We inherited these genes and, as such, we are inherently negative. In addition, not only does our brain’s “alarm bell” use more capacity (two-thirds) to look for bad news, but this bad news imprints far more quickly and lingers longer in our memory (in contrast to positive events and experiences, which are usually only held in our consciousness for a dozen or so seconds). There is positive-negative asymmetry.

 

Thanks to evolution, our biological and chemical make-up, we register and recall the negative over the positive. Did you really have a bad day, or did you only have a bad ten to twenty minutes during the day? Have you found yourself fixating on past mistakes or insults but rarely take note of your achievements or the compliments which you receive? Does it cause you more pain to lose money than the pleasure of gaining an equivalent amount?

 

This last one is an example of another behavioural bias called loss aversion as explained by prospect theory and explored in detail in the book Thinking, Fast and Slow and other works by Daniel Kahneman, a Nobel prize-winning economist. Kahneman did extensive research and writing in applying psychological insights to economic theory, especially with regards to making judgements and decision making.

 

So, not only are we subjected to bad news more regularly and easily, we also tend to focus on this more. Unfortunately, we cannot do much about the way in which news is reported since sensationalism sells. However, what we can do, is change the news that we actively seek out, and our subsequent interpretation thereof.

 

One of the best gifts I received last Christmas was a book (books always make for the best gifts). Unfortunately, I only started reading it recently. Although, in retrospect, maybe I started reading it at exactly the right time. I am an inherently positive person, but the past few months I have felt myself being weighed down by negativity.

 

“It is easy to be aware of all the bad things happening in the world. It’s harder to know about the good things; billions of improvements that are never reported.”

 

The book I received and I am reading, which I think every single individual, and investor should read, is called Factfulness by Hans Rosling. This (Factfulness) is the one option available to all of us as individuals to manage our own mental and financial health. Factfulness is the stress-reducing habit of only carrying opinions for which you have strong supporting facts.

 

As a working example from the very document that you are reading, I would highlight Peter Armitage’s contribution to the Navigator entitled, SA’s corporate meltdown: Billions of rand vaporised. You could read just the title and assume the worst, or you could delve deeper into the details of the piece and understand the facts being explained. As he writes in his opening paragraph: “The temptation is to jump to the conclusion that SA business is fraught with malfeasance, but this analysis seeks to illustrate that, while there has no doubt been unethical behaviour, the majority of failures have been through a combination of bad luck, tough market conditions, one-off unanticipated events and poor judgement.” Similarly, Glen Baker’s contribution, SA Property: Light at the end of the tunnel? demonstrates that, even though the property sector is not immune to economic conditions, there may well be a structural change in the way investors value property and SA-listed property is now trending towards an equity-like profile, which is in-line with property sectors across US, European and Asian markets.

 

In addition, as he explains, there are some mitigating fundamentals being ignored which present valuations that make for a compelling investment case. Both of these articles should be read in their entirety for the whole message to be properly understood and this also applies to almost any information we consume, albeit research, news, books etc. Of course, there are articles and news reports which are not even based on facts so it’s always important to curate what you consume and not only how you consume it.

 

The sub-heading of Factfulness is Ten reasons we’re wrong about the world – and why things are better than you think. Hans and his collaborators, Ola Rosling and Anna Rosling Rönnlund, offer a radical new explanation of why we are wrong about the world and why it is better than we think. They reveal ten instincts that distort our perspective and how to overcome these behavioural biases. His second reason, and Chapter Two explains the negativity bias, “our tendency to notice the bad more than the good”, as referred to earlier. There are numerous examples and stories and, most importantly, facts. In summary, we are negative because we misremember the past, are exposed to selective reporting by journalists and activists and a part of us feels heartless to say that things are getting better when some things are still bad (even if they are improving).

 

 

It is easy to be aware of all the bad things happening in the world. It’s harder to know about the good things.

On page 7 in the first few paragraphs of our Strategy and Asset Allocation section, we speak to the latter – we acknowledge that, even given the work that needs to be done locally and globally, we are pleased to see that the direction of change is improving. We need to recognise when we get negative news and remember that bad news is far more likely to reach us, and stay with us, than good news. Nick Dennis’s article entitled, Investing in uncertain times: What would Peter do? speaks to this wisdom and Nick quotes Peter Lynch who echoes this sentiment throughout. He summarises by noting that often we are our own biggest hurdle due to all the (usually negative) noise, but highlights that if we focus on companies (the facts) and maintain an optimistic outlook we will reach “nirvana”.

 

The world is constantly changing, and it is important for us as investors and individuals to update our knowledge and worldview accordingly. In my previous article for the Navigator, I wrote that financial integrity encompasses understanding why you manage money in the way that you do and if you are feeling competent to either continue in that manner, or to make the necessary changes. In this article, I want to encourage you to understand the type of information you are consuming and to make sure that you are making your decisions based on FACTS and not on your primordial negativity instinct. If you are not, make the necessary changes or allow us to assist you. Seeking out positive facts and factual news will not only improve your mental health but, as a result, your financial health as well.

by Tamzin Nel, Portfolio Management, Anchor Capital

Act 1: Reclaim the state

I believe that we are all guilty at times of being consumed by the pervasive negative news. In this article JP Landman writes an objective honest piece about what we are getting right.

“Just do something” is the cry now rising from all over SA, a plea to the President and government in general to take some action to break the logjam in which the country finds itself.  Confidence is low, growth sluggish and emigration high.  It is useful to recapture what has been done.

The Ramaphosa administration has set itself two tasks: to rebuild the ethical foundations of the state and revitalise the economy.  The two topics are too much to cover in one note, so I will discuss ethical renewal in this note (Act 1) and assess economic renewal in the next one (Act 2).

Cleaning up and re-building ethics

The country first and foremost had to be reclaimed from the forces of state capture.  Ramaphosa appointed four commissions of enquiry to help with the clean-up offensive.  Two are still in session (the ubiquitous Zondo Commission and the Mpati Commission into the PIC) and two have finished their work.  Between them the four has sparked considerable action – a lot of which we have already forgotten about.

Freeing critical institutions

It is useful to remember that both the erstwhile number 1 and 2 in SARS, Tom Moyane and Jonas Makwakwa, are gone.  So is that embarrassing former head of IT at SARS, Ms Makheke-Mokhuane, who made such a spectacle of herself on national television that she publicly apologised for it.  That is not all: in the last week of July three SARS executives were suspended.  The clean-up continues.  The EFF and the Public Protector are fighting a rear-guard action against SARS renewal with old allegations of rogue units and attacks on new Commissioner Kieswetter.  He is forging ahead unperturbed and can leave the Public Protector to the courts.

At the NPA the erstwhile top 3 have also departed and a woman with experience at the International Court in The Hague has returned to SA to take up the baton.  The departure of the three has freed the NPA from its era of Zuma capture and it is being rebuilt.  (One is fighting her dismissal in court and two have appealed to Parliament not to be fired.  It will be an interesting test case for who is in charge in Parliament.)

Director Batohi took office in February. In March a special investigative unit to focus on cases arising from state capture revelations was formed.  In May Batohi brought in well-known corruption buster Hermione Cronjé to lead the new unit.  Like Batohi herself, Cronjé has international experience and returned to SA to take up the role.  A senior advocate from the Cape Town Bar, Geoff Budlender, has been appointed as strategic advisor to this unit.  Batohi has re-appointed Willie Hofmeyr as head of the asset forfeiture unit after he was side-lined three years ago by the Zuma squad.  I wrote in this newsletter in April that 2020 will be the year of prosecutions and I explained why then. I stick with that call.

Over at the Hawks both the former head and acting head have been fired and replaced by the soft-spoken and highly regarded general Godfrey Lebeya.  His influence is showing: two captains and a warrant officer from the Hawks were arrested for bribes.  In Durban both the mayor and a councillor have been arrested by the Hawks and have appeared in court (with the usual tweet from Zuma supporting the mayor and with her supporters protesting outside the courthouse).  Two senior officials from the Durban Metro were also arrested.  A mayor of Newcastle was arrested for an alleged (political) murder; as was a former mayor of Endumeni for alleged conspiracy to murder.  Not bad for an erstwhile Zuma and current ANC stronghold.  In the Free State nine civil servants and a director of a company was arrested and charged – one for interfering with the work of the Hawks. In Mpumalanga a former local ANC chief whip was arrested on corruption and fraud.  The Hawks are clearly at work.

In Limpopo the VBS report claimed the scalps of five mayors who resigned, four more who were fired and three who were suspended.  In North West three mayors resigned, one was suspended and three have taken legal advice to try and avoid dismissal. Public opinion counts – especially in the run-up to an election.

At SAPS a deputy-commissioner has been fired and six officers of general or brigadier rank have been charged.  As recent as last week seven junior officers were arrested for selling confiscated goods back to hawkers.  In a significant ruling one of the “untouchables”, former head of Crime Intelligence Richard Mdluli, was convicted in July on several charges for offences committed twenty years ago in 1999.  The wheels of justice turn slowly, but they turn.  (As John Block, the former ANC strongman in the Northern Cape and Zuma acolyte also discovered – after many legal manoeuvres he is now serving a 15-year jail sentence.)

The ubiquitous SOEs

The SOEs are still burning cash and their balance sheets are shocking, but on the ethical front a lot has happened.

At Eskom former big bosses Brian Molefe, Anoj Singh and Matshela Koko are gone.  Molefe has also been pursued by Solidariteit and must now repay R10 million to the Eskom pension fund.  365 Eskom managers were subjected to lifestyle audits, resulting in 44 cases being referred to the Special Investigating Unit.  More than 1 000 disciplinary cases were instituted, and 116 employees decided to resign, including 14 senior executives.  Of 25 employees who had “business interest in suppliers dealing with Eskom” seven resigned and the rest terminated their interests.  Eskom has seen a serious clean-up.

A year after the notorious Hlaudi Motsoeneng was dismissed from the SABC, three of his erstwhile henchmen are gone too.  (The verbose Hlaudi failed with court challenges to regain his job and then went on to fail again in his election efforts to get into Parliament.)  In an important self-initiated report published last week, compiled by veteran journalist Joe Thloloe, the broadcaster laid bare political interference in its editorial policy.  Former minister Faith Muthambi complained she was “rubbished” in the report … could not happen to a nicer person.  Expect further fallout from the Thloloe report.  A Zuma-appointed chairman in still in place at the SABC and the corporation wants a mere R3 billion to stay afloat, but cleaning up has certainly taken place.

The PIC saga is still on-going before the Mpati Commission, but already a new board is in place, the CEO is gone, and so are two senior executives.  A number are on suspension.  In an important break with the past, cabinet reversed the practice of a politician chairing the board.  Under new chair Reuel Khoza’s experienced leadership and rock-solid integrity the PIC will, with a little help from the Mpati Commission, clean up properly and head in a new direction.

At SAA the former Zuma acolyte Dudu Myeni is gone – in his second stint as Minister of Finance Pravin Gordhan desperately tried to get rid of her.  Now Zuma is gone, Myeni is gone, as are several former senior executives.  Everybody can see how the once-mighty has fallen.  Now there is only the small matter of staying afloat.

At Transnet five executives, including the CEO, departed and eight more are on suspension.  At Denel the CEO, finance chief and chair are all gone.  Both organisations have new boards.  It may not be enough to save them financially, especially Denel, but action has been taken against weak ethics.

Cabinet

Perhaps the biggest clean up took place in cabinet.

Ramaphosa inherited a cabinet of 36 ministers. There are now 28.  At most five of those can be described as Zuma- or Magashule-supporting.  (And even some of those will deny it.)  40 government departments have been reduced to 35.

For all the publicity that was given to erstwhile Zuma ministers who were appointed chairs of parliamentary committees, the numbers speak for themselves.  There are 36 committees in Parliament.  Traditionally the Select Committee on Public Finance (Scopa) has an opposition party member as chair. That is the case again in this parliament.  Of the remaining 35 committee chairs, 11 may be regarded as Zuma- or Magashule-supporting people.  Most of these are ministers who were kicked out of cabinet.  From a minister to a chair of a parliamentary committee where every move is watched by opposition parties … and now we are asked to believe that they are paralysing government …?

So What?

  • Part of Ramaphoria was the belief that the bad guys would lose.  That is certainly happening.
  • People who were once untouchable have fallen from grace for all to see.  Some have even been convicted already.  The impunity of the Zuma years is slowly being reversed.
  • The process is not over with the Zondo Commission still in session and almost weekly revelations of bad-guy behaviour.
  • Getting convictions in court is very different from revealing things at a commission. Despite that many people have already fallen on their swords.
  • Civil society organisations have helped in this clean-up and that speaks volumes for SA’s democratic activism.
  • In the next edition we will focus on the second priority of the Ramaphosa government – economic renewal (Act 2).

JP Landman

Political & Trend Analyst

Graphic design and color swatches and pens on a desk. Architectu

Prescribed Assets

What are ASISA’s views on prescription of assets and why?

When the term “prescribed assets” is used, it is understood to refer to Government forcing the savings industry to buy Government stock as well as bonds issued by State Owned Enterprises (SOEs) on behalf of investors like retirement funds. This concept was first introduced by the previous Apartheid government and has been raised periodically over the years by various political parties.

It did not work when introduced by the Apartheid government and ASISA and its members maintain that it would have negative effects on the country should it be introduced now.

The savings and investment industry, as represented by ASISA, has engaged extensively with various relevant parties on the potential impact of “prescribed assets”, including directly with Government Ministers tasked with infrastructure development, via Business Unity South Africa (BUSA) into the National Economic Development and Labour Council (Nedlac), and via the CEO initiative.

The Government under President Ramaphosa has been very collaborative as evidenced by the various engagements like the Jobs Summit, Investment Summit and the ongoing engagements with the CEO initiative. If “prescribed assets” are again tabled for discussion by Government, we believe engagements with our industry will be equally constructive.

ASISA is empowered by a mandate from members that manage some R6.2 trillion of the nation’s savings and investments and is therefore recognised as a significant and relevant partner around Government’s negotiation table. We regularly engage on a number of issues regarding policy, regulatory reform and other issues of national priority such as economic transformation and inclusion.

Why do we oppose “prescribed assets”?

  • The concept of “prescribed assets” would force the savings and investment industry to deploy the savings of ordinary South Africans into entities that have over the recent past been mired in State Capture and lack of delivery. As custodians of these savings we have to oppose this.
  • Asset managers are not asset owners. The bulk of the assets that could be prescribed are owned by retirement fund members. It also needs to be noted that roughly half of these assets are held by the GEPF and are therefore owned by public servants. As the owners of these assets, ordinary South Africans elect and appoint trustees to make asset allocation decisions that are in their best interest. Prescription would jeopardise this fiduciary duty.
  • Prescription of assets interferes with the capital allocation function of the capital markets, which should always be objective and driven by performance. Forcing the market to invest in low yielding and/or high risk projects could have two direct consequences:
     – The incentive for these projects to compete would be removed as funding would no longer be incentivised by performance.

– Given that capital is a finite resource, deserving projects could be deprived of funding. These projects that would otherwise have driven growth and created sustainable employment would now not happen anymore.

  • Prescription would have a negative impact on the country’s credit rating. If South Africa loses its investment grade rating, foreign investors, many of whom are pension funds, would be forced to withdraw their money from South Africa. This is something the country can ill afford.

Working with Government on infrastructure finance

ASISA has always maintained that the problem is not the lack of willingness of capital markets to invest, but rather the absence of viable projects. We are engaging with Government to address this with urgency.

ASISA and its members believe that many of our country’s challenges can be overcome through effective public private partnerships (PPPs).

ASISA was therefore represented by several of its Board members as well as senior policy advisers at President Cyril Ramaphosa’s Investment Conference last year, which took place under the theme “Accelerating Growth by Building Partnerships”.

ASISA is actively involved in working with Government on infrastructure finance for water, energy and student accommodation. We are also looking at collaborative delivery mechanisms with Government and the Development Bank of Southern Africa (DBSA) for programmatic financing solutions.

ASISA members have already deployed more than R1.3 trillion in support of Government, Local Authorities and State Owned Companies.

In addition, our industry has made direct investments of R200 billion into the following projects:

  • Renewable energy
  • Township development
  • Affordable housing
  • Urban regeneration
  • Student accommodation
  • Water
  • Roads
  • Agriculture (emerging farmers)

When to sell?

Investors are encouraged to stay the course, but look out for warning signals to re-evaluate a fund.

Generally, you should not alter your investment strategy or its execution unless it was incorrect at the outset, or your personal or financial circumstances change. At crucial points, such as when you get married, have children, get retrenched or retire, we strongly recommend that you consult a qualified financial advisor. Absent such change, the basic rule is: “Do not let shorter-term market fluctuations and negative market commentary sway your commitment to your long-term investment goals.” There is much research that supports the view that investor behaviour is a destroyer of investor returns1, and that investors should “stay the course”.

Having said that, we believe that you should re-evaluate a fund in which you are invested if one of the following warning signals is triggered:

  • Change in the portfolio manager(s) and/or the supporting analyst team

The portfolio manager is the key individual responsible for delivering on the fund’s stated investment objective. Prior to making your investment, you (together with your financial advisor) would have evaluated the portfolio manager’s ability to deliver on the fund’s mandate. A change in portfolio manager necessitates an evaluation of the new portfolio manager’s ability to continue to do so.

In most instances, a portfolio manager is supported by a team of investment analysts. It is likely that these analysts play a significant role in the fund meeting its investment objective over time. Therefore, changes to the analyst team also necessitate the re-evaluation of the fund.

  • Evidence of investment philosophy drift

When selecting a fund to assist you in meeting your long-term investment objectives, you may have done so based on the portfolio manager’s investment philosophy, for example value, growth or momentum-focused. It may be that after a period of underperformance because the investment style has been out of favour (value underperformance comes to mind over the past eight or so years), the portfolio manager starts to drift away from his stated investment philosophy. This style drift will likely result in the fund neither meeting its investment objective over time nor fulfilling the role for which you selected it. This should therefore trigger the re-evaluation of the fund.

A fund such as the Investec Diversified Income Fund aims to participate when the bond market outperforms cash and protect when the bond market underperforms cash. As illustrated in Figure 1, the fund has been able to consistently deliver on its cash plus objective over time. It is this sort of consistency through various market regimes that is important when considering which funds to include in your portfolio, as you need to be confident that the fund will continue to behave as you expect into the future.

1 Dalbar’s Quantitative Analysis of Investor Behaviour Study has been analysing investor returns since 1994 and has consistently found that the average investor earns much less than what market indices would suggest.

Figure 1: Investec Diversified Income Fund: average rolling 12-month excess returns over cash

Source: StatPro and Bloomberg. Returns are calculated on a true daily time-weighted basis net of fees. Periodic returns are geometrically linked. Data from 30 September 2010 to 30 June 2019.

  • Asset manager corporate action

Change in the ownership structure, particularly where the asset manager has been acquired by a third party can be very distracting for all staff, including investment professionals, if not managed correctly. Portfolio managers and investment analysts are only human, and a change in ownership could result in an inward focus. Independent, focused asset managers with significant staff ownership are well aligned to delivering on client expectations through time.

  • A better alternative emerges

While the fund selected may continue to meet its investment objective over time, it may be that a better alternative emerges. It is important then that financial advisors (and their support team / fund selection partner) continue to research the peer group. If an alternative fund consistently delivers better risk-adjusted returns, it may make sense to introduce this fund into your portfolio.

  • Value for money

It is important to ensure that you are sufficiently rewarded over the long term for the fee that you pay. A lower fee may not necessarily be an indicator of a better net return outcome. On the other hand, a higher fee needs to be scrutinised to ensure that you get value for money.

  • Luck rather than skill

When you made the initial investment your analysis suggested that the portfolio manager had a demonstrable skill. But over time it now appears that, for whatever reason, this outperformance proved to be because of luck not skill. A re evaluation is warranted given that luck is not enduring through time.

  • Material changes to the economic and investment environment

Over time economies are expansionary and investment markets deliver positive returns, but both may become over heated. At this point it may make sense to de-risk your portfolio by reducing exposure to high beta funds (funds that follow a momentum investment philosophy, for example) and introducing more defensively-positioned funds (for example, funds that follow a quality investment philosophy). Unfortunately, timing such a move is extremely difficult and therefore it makes sense to include a defensively-managed fund to which you maintain exposure through the cycle.

 

While funds such as the Investec Cautious Managed, Opportunity or Global Franchise Funds meaningfully participate in strongly positive markets they demonstrate the true strength of the Quality team’s approach in sideways-moving and negative markets. The result is that they outperform through the market cycle, as illustrated in the following graph of the Investec Opportunity Fund. This enduring performance signature has benefited long-term investors.

 

Figure 2: Investec Opportunity Fund – relative strength in sideways to down markets

*Data since May 2000. Source: Morningstar, dates to 30 June 2019, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested, fees are not applicable to market indices, where funds have an international allocation this is subject to dividend withholding tax, in South African rand.

Conclusion

While this list is not exhaustive, it provides some warning signals that should trigger the re-evaluation of your current fund holdings. Importantly, any change should be carefully considered in the context of your overall investment objectives and any potential capital gains tax consequences, which we will consider in a follow-up article. Again, we would recommend that you consult with a qualified financial advisor.

Important information

All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). A feeder fund is a fund that, apart from assets in liquid form, consists solely of units in a single fund of a collective investment scheme which levies its own charges which could then result in a higher fee structure for the feeder fund. The fund is a sub-fund in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act.

This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Issued by Investec Asset Management, September 2019.