Dispelling the myth around low-cost investing
The origins of the Nedgroup Investments Core range dates back to more than a decade ago when financial advisors requested solution funds that would fit into a holistic financial planning model. A directed model which focuses on matching clients’ future expected cash flow needs with portfolios that target specific real returns objectives. It also sought to achieve longer term holding periods and avoid the investor behaviour penalty that is often associated with clients moving from underperforming funds into recent top performing funds, just at the wrong time. Rules-based (passive) balanced funds, with market linked asset class performances were therefore preferred because they could be easily explained to clients and due to the low cost nature could increase the probability of meeting the clients real return requirements after all costs and taxes.
In order to address these requirements, the Nedgroup Investment Core Diversified Fund was launched in August 2009 as the first low cost multi-asset unit trust portfolio in the South African market. Five months later, its more conservative brother, the Nedgroup Investments Core Guarded Fund, was launched, and over the past seven years these funds have built up enviable track records and have dispelled the myth around low-cost rules-based investing1 along the way. The myth that low-cost investing delivers poor risk-adjusted performance was mainly due to low cost rules-based strategies not being tested in the South African market. Some intermediaries also perceived low cost investing to be in conflict with their value-add of picking the next top performing active fund for their clients. The portfolios in the Nedgroup Investments Core range are highly diversified and provide exposure to five domestic and five offshore asset classes (equity, property, bonds, inflation-linkers and cash). The strategic allocations to these asset classes are constructed to maximise the likelihood of meeting the portfolios’ objectives over their stated investment horizons. The Nedgroup Investments Core Diversified Fund targets a return (after all costs) of inflation + 5% p.a. over rolling five-year periods while the Nedgroup Investments Core Guarded Fund targets a return (after all costs) of Inflation + 3% p.a. over rolling three-year periods.
Establishing a good track record
The Nedgroup Investments Core Diversified Fund recently celebrated its seventh anniversary. The table below shows the fund returns, risk and TERs over this period versus its competitors. As the 10 largest funds make up over 80% of the assets in the South African Multi-Asset High Equity category it is more realistic to compare the Nedgroup Investments Core Diversified Fund’s performance versus the median of these funds.
On a risk-adjusted basis measured by the Sharpe ratio the fund is ranked tenth out of 56 funds over the seven-year period. Similarly, the Nedgroup Investments Core Guarded Fund has performed well over the past six years and seven months with a Sharpe ratio which is ranked ninth out of 66 funds.
Managing risk through diversification
Both funds performed well on a risk-adjusted basis versus their peers; partly due to their low overall costs and broad diversification. In the tables above we can see that the funds’ total expense ratios (TER) are over 1% less than their typical peers which illustrates how important costs are over the long term. The broad diversification of the funds also means that performance came from different sources and that the volatility of the funds was significantly less than most of the individual asset classes.
The broad diversification of the funds also allows them to weather different market shocks and economic environments. In the charts below we illustrate how diversification has aided the funds through different market shocks, such as a drop in commodity prices, market drawdowns and changes in inflation2. For example, the importance of the offshore diversification in counteracting equity market drawdowns can be clearly seen for both funds.
Contrary to advisors first impressions, low costs did not imply cheap as the lower cost incurred in the Core range has actually added to performance relative to peers as reflected above. Importantly, diversification has reduced volatility and should reduce risk to different economic shocks going forward.
Particularly from a financial planning perspective the Nedgroup Investments Core range is also ‘future fit’ as the costs are transparent and there are no performance fees. These funds can be used as standalone solutions or combined with traditional active multi-asset portfolios as an effective tool to reduce the overall costs incurred by investors throughout their life cycle.
2Source: BlackRock. The analysis date is 29-JAN-2016, the base currency ZAR and the risk model is BlackRock’s Fundamental Equity Risk Model (BFRE World Equity). We are using 6 years of monthly observations with a 36-month half-life. For ex-ante risk we are using a Confidence Interval of 84% (numbers used will only be exceeded 16% of the time during any one year period, which represents 1 standard deviation from the mean).