Page 108 - Profile's Unit Trusts & Collective Investments - March 2026

Chapter 6 Investment risk

One way to judge organisational risk is through the way in which the company deals with investors.
If service levels are poor and reports are late, there is every chance that the same poor standards are
tolerated in the asset management division.
Liquidity risk
Liquidity risk refers to both the liquidity of the cash component of the fund and the liquidity of the
stocks in the fund. The latter is a more technical issue which generally only needs to be considered
for small, focused funds. For example, smaller JSE companies tend to be relatively illiquid (ie, their
shares can be difficult to sell quickly), which makes it difficult for small cap fund managers to adjust
portfolios if small cap stocks fall out of favour, as they did in 1999. Some larger companies are also
tightly held and a fund heavily invested in illiquid shares might find itself relatively “locked in” in a
bear phase.
The issue of liquidity levels within funds is a more important one. Collective investment schemes,
even those classified within the same sectors, sometimes have different mandates with regard to
their overall liquidity levels. Some mandates require the fund managers to be as fully invested as
possible, while others are permitted to operate within the requirements of the ASISA guidelines,
which would allow, for example, a general equity fund to be as much as 20% liquid. Liquidity can
have a significant impact on performance.
A general equity fund which is 20% liquid in a bear phase is not as exposed to the falling market, but
the same liquidity level in a strong bull phase will almost certainly cause the fund to underperform.
Stock picking risk
As we said earlier, having all your eggs in one basket is a great strategy – provided you pick the
right basket.
One way to achieve superior returns is to concentrate your investments in a smaller number of
winning shares. This is something that Warren Buffet is famous for, and his wealth is testimony to
the success of this strategy. There is no question, however, that all things being equal, concentrating
on a smaller number of stocks generally increases the risk level. Stock picking requires in-depth
knowledge of the market, the economy and particular companies.
Stock picking risk can, of course, be reduced through diversification. Index funds are an effective
way of almost eliminating stock picking risk, because they aim to mirror the performance of a market
index and are therefore only exposed to particular shares to the extent the index itself is exposed.
When it comes to actively managed equity funds, which rely considerably on stock picking, the
proven track record of the fund manager is an important consideration.

Measuring risk
As mentioned earlier in this chapter, risk is hard to define – the word means different things to
different people. How to measure or quantify risk can, therefore, be a contentious issue.
Some common measures of the riskiness of unit trusts are volatility, beta, alpha, maximum
drawdown and r-squared. (Ratios like Sharpe and Sortino also address risk but provide risk-adjusted
returns rather than “pure” risk measures.)
Active returns
The types of risk covered in the previous section can broadly be divided into two categories: on
the one hand, risks inherent in assets classes and where they are domiciled, and on the other, risks
associated with decisions made by fund managers and investors.
As we have seen, the performance of asset classes (and sectors or sub-divisions within assets
classes) are measured by indices which are used as performance and risk benchmarks. A long-
term investment which replicates an index or benchmark, known as a passive investment, is mainly
subject to benchmark risk – ie, because the investor or fund manager is simply riding the ups and
downs of the asset class or sector, the risk factors associated with stock picking and market timing
are minimised or precluded.
The investment returns produced by a particular asset class or sector (as measured by a
benchmark) can be referred to as passive returns – ie, the investment performance inherent in the

106 Profile’s Unit Trusts & Collective Investments March 2026