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A free lunch most active managers didn't take

Those South African equity funds able to diversify offshore should have comfortably out-performed. So why didn't they?

A free lunch most active managers didn't take

For the five years to the end of May the FTSE/JSE All Share Index (Alsi) was up just 2.5% per annum. In contrast, the MSCI World Index had gained 11.6% per annum in rand terms.

This miserable period for South African stocks relative to global markets has been particularly heightened over the past 12 months. Over one year, the Alsi was down -4.8%, compared to a 23.8% gain on the MSCI World Index in rand terms.

In this environment, it is pretty clear that diversifying offshore has been an extremely useful lever to pull. The returns available internationally have been able to offset the poor performance on the JSE.

It is therefore worth asking how well local equity fund managers made use of this opportunity. And, particularly, whether it was a key determinant of recent success.

Not everyone was on board

The first thing to note is that the majority of South Africa general equity funds actually have no offshore exposure, according to portfolio statistics from Morningstar. Of the 161 unit trusts in this category with at least one year track records, 92 are invested exclusively in local assets. That is 57%.

Of those, 11 are top quintile performers over the past 12 months. That is a ratio of 34%. Only one is in the top 10.

Funds with no offshore exposure are therefore meaningfully under-represented amongst the top-performers over the past year.

The picture does not change much when considering a five year period.

Looking at funds with track records that extend back at least 60 months, 53 out of 109 have no offshore equity exposure. That is 49%.

Of the 21 top quartile funds over this period, eight do not invest beyond the JSE. That is a slightly higher ratio than over one year, but is still only 38%. Once again, funds that invest offshore are more likely to be top-performers.

But wait

Logically, this should not be surprising. International equities have so significantly out-performed local stocks over the past five years that having offshore exposure should have been a meaningful driver of returns.

In fact, this divergence has been so significant that it should have been extremely difficult for funds with no international exposure to keep up. The surprising factor is therefore not that funds that invest exclusively in South Africa are under-represented amongst the top-performers. It is that a fair number of them still appear on the list.

What is most remarkable of all, perhaps, is that the Gryphon All Share Tracker fund is a top quartile performer over the past five years. This is a fund that tracks the performance of the Alsi. It is ranked 18th out of 109 funds for this period, meaning that it out-performed 84% of the category.

Given that local equity funds are allowed to invest up to 30% offshore, and given the extreme divergence between the performance of international and local markets, it is striking that this passive fund should be a top-performer amongst active managers who have largely been given a free lunch.

Simply maintaining a 25% exposure to the MSCI World Index over this period would have translated into a 2.9% in annualised return. That would have been enough on its own to out-perform the Gryphon tracker fund. All managers had to do in the rest of their portfolios was not lose money.

It is what you did with it that mattered

Of course the performance of both the JSE and world markets have been driven by a narrow selection of stocks over the past five years. Index returns have therefore been difficult to beat just about anywhere.

That has made this period even more challenging for active managers.

However, it is nevertheless worth asking whether any fund that held meaningful offshore exposure and still under-performed an Alsi index tracker wasn’t destroying value rather than creating it. Pulling that international lever should have been a simple asset allocation decision for any fund that was allowed to do so.

That many did, and still fell behind both the index tracker and many of their peers who were unable to access international markets should raise questions. Investors should be asking them.



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