Back-to-basics: Share portfolio vs collective investment scheme

Over the past ten months or so, we have experienced turbulent times in the investment universe. YTD (to 30 September), the S&P 500 Index is down 24.8%, while the MSCI World Index is down 25.1%, leaving many investors wondering if we have finally seen the bottom of this market correction. While we can never reassure our clients that this is the end of the market volatility we have seen since late last year, it is important to remember that timing the market is a fool’s game. Moving into the final quarter of 2022, we emphasise that time-in-the-market has historically beaten timing the market. Investing dry powder in smaller tranches is perhaps the correct approach to managing this market volatility.

In saying this, we thought it would be valuable to break down the pros and cons of both a share portfolio and a collective investment scheme (CIS). Generally, this is one of the first dilemmas clients face when deciding to invest in equity markets.

Share portfolios allow for portfolio managers at Anchor to create a bespoke solution focused on each client’s personal circumstances and investment goals. Share portfolios are often the proverbial ‘sexier’ option as individuals can be directly invested in some of the most attractive businesses in the world, such as Apple, Nike, The Walt Disney Company (Disney), etc.

Our clients’ investment needs range from capital-growth focused to an income-yielding share portfolio. This flexibility affords both Anchor and its clients multiple benefits. These include:

1. The ability to take a phased approach to build up an investor’s equity content, especially given the volatility experienced recently in global and local markets.
2. The ability to be nimble within a portfolio and make changes relatively quickly if a changing investment landscape necessitates this.
3. When managing an offshore investment, Anchor’s approach to buying hard currency to invest offshore can be made using a phased approach as opportunities arise.
4. Fee structures are clear. Brokerage is charged on each trade made as a percentage of the value of that trade, and an annual management fee is charged on the asset under management.

An important consideration when managing a share portfolio is taxes. Portfolio managers must be cognisant of any capital gains inherent within a portfolio when rebalancing to minimise the capital gains tax (CGT) implications. In saying this, Anchor has always been platform agnostic, and we do recommend structures to manage this risk when appropriate.

While segregated share portfolios have been our bread and butter over the past ten years, it is important to consider other investment options for clients where these are appropriate.

CIS (unit trust funds) allow investors to pool their funds together within one structure managed by a professional fund manager to achieve a specific mandate. Traditionally, a unit trust fund is recommended to clients with investment values of less than R1mn due to the following:

1. The fund can achieve a more diversified portfolio of shares with a pool of funds.
2. A fund is more cost-effective given the lower brokerage costs, which would otherwise erode the capital value of the investment.
3. Clients seeking offshore exposure with smaller investment values can invest in feeder funds. This way, they gain access to offshore markets without incurring the costs of converting their capital to foreign currency and the larger platform fees which exist, given investment minimums.
4. CGT is only paid on exit from the fund, thus allowing a client to benefit from the effect of compounding and not hindering the fund manager’s ability to rebalance the portfolio.

While there are several benefits to unit trust funds, a few key points to consider before investing in such a fund is also worth mentioning. These include:

1. The ability of a fund manager to be nimble and react to changes in the investment environment can be difficult due to liquidity constraints in larger funds.
2. Over-diversification is possible when holding multiple funds, often leading to an unclear overall investment strategy.
3. The ability to time the market in terms of the initial investment is somewhat hindered as investors cannot phase in their investment with specific stock selection.
4. A fund-of-funds approach can be quite expensive due to the multiple layers of fees charged by the various underlying managers

Over the past five years, our role as portfolio managers has shifted from the more traditional role, which solely involved using fundamental bottom-up analysis of equities to select a portfolio of quality shares and relying on the ability of the market to price in these fundamentals. Anchor CEO Peter Armitage refers to Nike as the poster child for the volatility we are currently experiencing. We consider Nike to be a best-in-breed, high-quality company and brand. In November 2021, the share price seemed expensive, trading at around US$180/share. However, it has since fallen c. 52% from its closing high of US$175.83/share on 5 November 2021, and on 30 September 2022, it closed at pre-COVID-19 levels of c. US$83.12/share. Nevertheless, it is arguable more valuable than ever as the business moves out of the supply chain blockages caused by the pandemic and now sells a large percentage of its merchandise direct to the consumer, thus creating a tailwind for future earnings.

Examples like Nike have forced Anchor to evolve its investment process and look outside its traditional toolbox into instruments which allow us to take advantage of these fast-changing waters. Where the client’s financial wealth allows, we prefer to use a core-satellite approach, enabling us to enhance profit while providing our clients with greater consistency in terms of results. At the core of the investment is a bespoke segregated portfolio of carefully selected quality shares which maintain a long-term buy and hold strategy. We like to complement this strategy with satellite funds (where appropriate), with specific exposure that assists in achieving the client’s financial objective, takes advantage of short-term opportunism, and has a better opportunity for risk-adjusted returns and a complementary investment style.

We mainly look to alternative asset classes to achieve this.

Hedge funds have historically had a bad reputation within the market, given their ability to use gearing, which has in the past left the funds overexposed to the market. However, in a conservatively managed hedge fund, clients can reduce the risk within their portfolio. Considering the current market volatility, this can be a complementary addition to a segregated mandate as the hedge fund manager has the mandate to profit from short-term volatility, which otherwise would not have been possible.

Structured products can also be a valuable option when investing, especially given their ability to de-risk the portfolio over the long term while still providing inflation-beating returns. Structured products are tailor-made investment products that can be linked to an index or basket of equities. In general, they have built-in barriers of protection (created using derivative components, the most common options), which limit the downside. Thus, investors forego some potential upside to limit the downside over a 3-to-5-year time horizon.

To conclude, while the title of this article suggests that our recommendation should be as basic as either a unit trust structure or a share portfolio recommendation to new clients, we are finding more and more that a combination of both these investment vehicles is the ideal way to navigate the ever-changing investment environment. As portfolio managers, we strive to guide and advise clients through these important decisions.