By: INGÉ LAMPRECHT
Is the underlying asset class of a unit trust a true reflection of the downside risk investors are faced with? Not necessarily. In fact, the risk spectrum of unit trust funds within the same subcategory in the local unit trust market can vary substantially.
An analysis by PlexCrown of the historic performance of around 327 South African unit trust funds (excluding money market funds) in the local market suggests that, in some cases, a certain unit trust fund may have exposed the investor to twice the downside risk (the risk of losing money) of another fund within the same unit trust subcategory.
Methodology
The PlexCrown Risk Ratings gauged the risk of losing money by investing in a specific asset class compared with other asset classes. The metric assigned risk scores of 1 to 10 to specific unit trust funds or asset classes (sub-sectors) within the overall sector, with 10 being the highest risk.
Money market unit trust funds are considered to be the lowest risk category, with downside risk of 0% and a risk score of 1. The downside risk increases by increments of roughly 2.75% for every increase of 1 in the risk rating, up to a maximum of 24.71% (or more) for a score of 10. The analysis is based on the calculation of the annualised downside risk of funds over rolling seven-year periods since 2002.
For example, the average downside risk for the general equity unit trust subsector over rolling seven-year periods until March 2013 was 14.0% annualised (a risk score of 6), while that of the equity financial subcategory was 17.3% annualised (a score of 7).
It is of vital importance for all stakeholders to recognise that funds that fall into a specific asset class category may have their own unique risk attributes, and the risk of losing money may differ substantially between various funds within the same subcategory, or from the sector average.
The risk of losing money in some funds may nearly be double that of other funds in the same category. An analysis of the SA Equity General subcategory of unit trust funds clearly shows how investment philosophies and strategies amongst funds can vary.
In the case of SA Equity General, 21 of the 69 funds analysed had risk ratings higher than the average of the subcategory, while ten had lower risk ratings. The deviations can be attributed to the styles of the different fund managers. It is therefore wrong and misleading to generalise and advocate that because funds fall in the same subcategory, they should be given the same risk class. It is essential that all be aware of the significantly diverse risk attributes of the funds despite it being classes in the same subcategory.
As in the case of asset classes, the downside risks of individual funds are dynamic-fund managers can be replaced, investment philosophies may change, funds may become large and unwieldy due to organic growth or investment management companies amalgamating all potentially causing fund managers to lose their edge against their peers.