Diversification no guarantee for consistent returns

“Diversify your portfolio” is an investment strategy which fund managers and analysts often tout. However, PPS Investments research analyst Laurette Ndzanga found that access to a well-diversified portfolio does not guarantee consistent returns.

Ndzanga’s analysis looked at balanced funds, also known as multi-asset funds, which are investment funds that combine different types of assets, such as bonds, money market instruments, equities (stocks), and real estate, into a single fund. 

Investors look to multi-asset funds aim to provide a balanced approach to investing by including high-risk/high-return assets like stocks for potential growth, while also including safer assets like bonds and money market instruments to reduce risk and generate income. 

The Association for Savings and Investment South Africa (ASISA) has a classification system that provides guidelines for the risk exposure of multi-asset funds. 

For example, multi-asset low equity funds are classified as funds that aim to achieve long-term capital growth with low short-term risk. These funds have a maximum allocation of 40% to equities, 25% to real estate, and 45% to offshore assets, which increased to 30% in February 2022.

However, Ndzanga found that easy access to a well-diversified portfolio through a multi-asset low fund does not guarantee consistent performance. Looking at the dispersion of net returns for these funds over the past ten years, there has been a wide range of returns each year.

The dispersion varied between 9.5% in 2017 and 31.1% in 2021. This means that different funds in the category had significantly different returns:

Source: PPSI/Morningstar

For example, in 2021,  when the fund has the widest dispersion of returns, riskier assets performed significantly better, while defensive assets underperformed.

In general, local and offshore equities and small capitalisation JSE shares significantly outperformed the more defensive asset classes, such as bonds and cash. 

On the other hand, 2022 was unique in that bonds were as volatile as equities, driven by the fastest interest rate hike cycle in history, and along with global equities and bonds showing negative returns. 

“This brought their traditional role as an equity diversifier into question. 2022 saw global cash and select local equities; resource shares and small capitalisation JSE shares drive performance.”

Ndzanga’s analysis also clearly shows that offshore assets have had a material impact on the dispersion of returns. Moreover, she said the increased offshore allowance would result in a wider dispersion of returns going forward. 

“Additionally, for a category with low equity exposure, high conviction equity views, whether it be in resources or small capitalisation shares will tend to have a significant impact on whether a fund leads or lags from a performance perspective,” she said. 

Other factors that can impact fund performance are the duration or interest rate risk.

“Simply having access to a well-diversified portfolio is not enough to guarantee consistent performance,” she said. “A manager’s investment style will influence how they allocate to the different asset classes and the type of equities they invest in, stock selection.”

“A more consistent performance could be achieved by selecting best-in-class fund managers within a particular style and blending fund managers with different styles.”


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