Michael Dodd, Senior Fund Analyst at Morningstar Investment Management South Africa

Recent changes to the Association for Savings and Investment South Africa (ASISA) Fund Classification Standard are poised to reshape the South African Equity fund landscape. The introduction of the ‘South African – Equity – SA General’ category catering to funds that invest exclusively in local shares is a milestone that brings clarity and comparability to a sector that has become increasingly complex. For investors, financial advisors, and asset managers, this development offers both opportunities and challenges that warrant close attention.

A new era for local equity funds

Effective 1 October 2024, ASISA’s updated Fund Classification Standard introduced a dedicated category for funds that limit their investments to South African equities. This change addresses comparability concerns resulting from varying offshore allocations among South African equity funds.

The new category distinguishes itself from the existing ‘General’ equity category, which allows funds to use offshore allowances. By separating these categories, ASISA ensures that peer group comparisons are now being made between funds with similar investable universes operating under the same constraints.

This is a positive step forward. Clearer fund classifications mean investors and advisors can make more informed decisions, and performance is being assessed on a level playing field.

Offshore exposure driving performance

One of the significant factors influencing the dispersion in local equity fund performance has been increased regulatory offshore investment limits, which rose to 45% in 2022. Funds leveraging this allowance have often seen their returns influenced by global market trends and currency fluctuations. As a result, the dispersion in returns between funds in the ‘General’ equity category has at times been wide, especially in periods where the performance difference between local and global equities is at its widest.

In years when global markets outperformed local markets, funds with higher offshore exposure generally delivered superior returns. For instance, in 2023, global equities outperformed local equities significantly, leading funds with material offshore exposure to dominate the top quartile of peer group rankings. In contrast, in 2022, local equities outperformed global markets and funds with minimal offshore exposure emerged as leaders.

Interestingly, for General equity managers there is no clear consensus on how to utilise their offshore exposure in their funds, with offshore weightings ranging from 0% to just under the regulatory maximum of 45%. However, when tracking the average offshore weights in these funds over time the trend of increasing offshore weights is clear to see.

Implications for the local equity fund landscape

The new classification standard is set to have far-reaching implications for investors, allocators, and asset management firms:

• Different target markets: The ‘SA-only’ category is expected to appeal more to institutional investors, such as discretionary fund managers (DFMs) and multi-managers, who prefer distinct local and offshore allocations. Conversely, the ‘General’ category may continue to attract retail investors seeking diversified exposure.

• Evolving benchmarks: While ‘SA-only’ funds will likely opt for local market indices as their choice of benchmark, ‘General’ equity funds face a more complex choice. Composite benchmarks, that reflect both local and global market exposure, and category averages are more prevalent benchmarks for these funds.

• Index funds: The ‘SA-only’ category is anticipated to become a natural home for index funds, given their focus on tracking local market indices.

• Offshore usage trends: The average offshore weight in the ‘General’ category is expected to move higher as funds not making use of their offshore allowance reclassify. Funds that have used their offshore allowance sparingly in the past may need to consider this allocation and the impact it may have on peer-relative performance.

• Product proliferation: Asset managers may launch new funds to cater to specific client segments, leading to increased choice in an already crowded market. The number of South Africa’s equity funds already exceeds the number of shares listed on the JSE.

Investor impact

As the dust settles on ASISA’s new Fund Classification Standard, the South African equity fund landscape is set for continued evolution. The distinction between ‘SA-only’ and ‘General’ equity funds offers a more transparent framework for performance comparisons, empowering investors and advisors alike. However, with increased offshore allowances and product proliferation, navigating this landscape will require careful analysis and informed decision-making.

Investors should work closely with their advisors to understand the implications of these changes for their portfolios. Choosing the right fund isn’t just about past performance; it’s about aligning with long-term goals and risk tolerance.

For investors and asset managers, the new era of South African Equity funds presents both challenges and opportunities—a fork in the road that demands thoughtful navigation.

To access Morningstar’s full research report on the Equity Fund Landscape: Read Morningstar’s latest in-depth research that explores the changes to the South African General Equity categories in the full report: An in-depth look at SA Equities

ENDS