Page 108 - Profile's Unit Trusts & Collective Investments - September 2025

Chapter 6 Investment risk

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 a three-year history. In addition to these quantitative ranking systems, some
companies also produce qualitative ratings based on evaluations by independent analysts.
In SA the main systems available to investors are Morningstar’s Star ratings and the PlexCrown ratings.
Both use a 5 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 4 or 5 point rating, therefore, should not be treated as a
“buy signal” but rather as one possible method of narrowing down the fund universe.

The opposite, of course, can also happen – that a currency strengthens while the market
weakens. If the JSE declined by 10% over a particular period and the rand improved by 10%
against the dollar over the same period, the net gain for a dollar-based investor would be zero (again,
ignoring dividends).
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 R1m per calendar year offshore
(as part of a general discretionary foreign exchange allowance), or up to R10m 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
may need to 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.

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