Page 110 - Profile's Unit Trusts and Collective Investments 2021 issue 2

CHAPTER 6

Crown and Star Ratings
Various companies use risk-rating systems designed to make it easier for investors to
assess the quality of funds on a risk-adjusted basis. The methodology used to produce
crown or star ratings typically combines measures of performance (alpha), volatility and
consistency to calculate a risk-adjusted return. Funds are ranked based on their scores, usually by
sector but sometimes by style, so that the best funds get the most crowns or stars. Usually funds are
only ranked if they have at least three years history. In addition to these quantitative ranking systems,
some companies also produce qualitative ratings based on evaluations by independent analysts.
In South Africa the main systems available to investors are Morningstar’s Star ratings and the
PlexCrown ratings. Both use a five-point system. These systems also rank management companies
based on the aggregate ratings of funds in each manager’s stable. The specifics of the methodologies
used are available on the companies’ respective websites.
From an investor’s point of view, crown and star ratings are a quick way of identifying funds with
consistent track records and good risk-adjusted performance. However, studies have shown that they
do not reliably predict future performance. A four- or five-point rating, therefore, should not be treated
as a “buy signal” but rather as one possible method of narrowing down the fund universe.

The currency effect is particularly important for overseas investors buying South African
shares. A significant portion of the JSE’s turnover is in shares which have traditionally been South
African but which now have their primary listings in other countries. For investors in those
countries (including asset managers), currency risk is often as important a factor as market risk.
Currency risk is obviously reduced by diversification – through offshore investment or through
funds that hold overseas assets. South Africans can also protect against currency risk (the risk of
the rand depreciating) by investing in certain JSE shares. Export-sensitive companies and
rand-hedge stocks perform well if the rand is depreciating, because these companies sell their
products for a higher rand price offshore. An appreciating rand, on the other hand, favours
companies that are reliant on imports and has a negative impact on rand-hedge stocks.
Geographic Risk
Even if international exchange rates were fixed, there would still be the issue of different
markets in different countries performing differently.
It is a peculiar phenomenon that major world equity markets often move in tandem – on
average, the London stock market is more likely to be rising when the American market is rising
than vice versa. But there are also periods when world markets are not in sync. German equity
markets might be falling while those in America are rising, or those in Japan might be moving
sideways while those in Europe are performing strongly.
South Africans over the age of 18 are allowed to invest up to R1 million per calendar year
offshore (as part of a general discretionary foreign exchange allowance), or up to R10 million
subject to tax clearance. Offshore investment allows South Africans to diversify their investment
portfolios, which is especially important as people get older. They should, however, take care to
ensure that their offshore investments are indeed contributing to a diversification strategy – South
African investors should avoid investing in other emerging markets or in funds dominated by
commodity-based companies (ie, in markets which share these strong characteristics of the JSE).
Sector and Asset Class Risk
Sector and asset class risk refer to the danger that a certain type of investment will fail to
achieve the desired result or erode capital.
The particular characteristics of the various asset classes available to investors makes them suitable
at certain times or under certain circumstances but not others. Interest-based products (especially in a
stable currency) may be a safe haven sometimes, but in the long term interest rates often fail to keep
up with inflation. The danger of eroding value in real terms over time is a major risk of “cash” (we
mean bank deposits, savings accounts and the like rather than folding money under the bed) as an
asset class, but there may be times (when equity markets are weak, for example) when cash might be
the better performing asset class.

108 Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts