If you are invested in one of the many local unit trusts that have exposure to the equity markets, chances are you have received a statement recently showing that your investment has produced negative returns over the last year.

In this circumstance, it is tempting to label the asset manager responsible for your investment incompetent. However, there are a number of factors that you need to consider, besides the nominal return, when evaluating their performance.

Don't measure in isolation

Firstly, the performance of your fund cannot be measured in isolation. Every unit trust fund is managed according to a specific mandate — which is simply a set of rules that determines, amongst other things, what the objective of the fund is, what the fund manager may invest in and what the fund’s benchmark is. The benchmark tells you what performance the fund manager measures himself against. There is no use getting angry at a fund manager if he underperforms the equity market when his benchmark is cash, as most of your money would be invested in cash. In other words, the old saying of comparing apples with apples applies here.

In fact, a fund’s benchmark is one of the first things to look for before investing in a fund. Not only does it tell you how you should measure the fund manager, but it also gives a good indication of what your future returns will be.

Fund managers generally aim to give investors returns at least equal to that of the benchmark. To do this they will invest the majority of your money into the assets that generate the same return as the benchmark. Outperformance (a return better than the benchmark) is achieved by taking bets away from the benchmark. For example, an equity manager may endeavour to beat his benchmark by holding more shares of a company in his portfolio than is held in the benchmark.

Time period a vital consideration

Another important aspect to consider when evaluating the performance of your unit trust is the time period over which you are analysing.

Many investors are unhappy with the performance of their balanced funds because they have underperformed money markets over the last year. Over the last year the Alexander Forbes Money Market Index (AFMMI) has returned 10.78 percent versus the average Balanced Fund, which has returned minus two percent.

Many investors cannot understand how this is possible. The fund manager, on the other hand, knows that if equity markets decline, this affects the fund’s performance, because he has allocated a significant portion of the fund’s portfolio to equities. He understands that in order to outperform inflation over a five year period, he needs to hold more equities than cash as equities have the highest probability of generating returns above inflation over the longer term. He also knows that by selling the equities in the portfolio when they are not performing well, he will realise a loss. A fund manager using a benchmark with a rolling period, forces himself to stay the course and produce higher returns.

Indeed, the return of the AFMMI over the last five years is 55.81 percent compared to the return of the average balanced fund of 97.28 percent. That is almost double!

There are a variety of benchmarks used in the local asset management space, all of which can broadly be classified into the categories found on page two...

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