Stick to a plan, as acting on market gyrations will harm your wealth, writes Chris Needham

BEWARE the seemingly safe option — that’s the message from two asset managers who warn that what might let you sleep easy in the short term could hurt your financial plans in the long term.

Tienie van der Mescht, managing director of Sanlam Collective Investments, says that the average investor’s aversion to risk might be misplaced.

“The man in the street is still investing conservatively,” he said.

Standard investment theory has it that you are rewarded with greater returns for taking on more risk (see box for the risk-return trade-off in funds). To achieve long-term growth of your capital, especially when it comes to seeing you through retirement, you are supposed to choose growth assets that will increase your returns over time.

Statistics compiled by the Association of Collective Investment show that investors’ aversion to losing capital is prompting them to put money into more conservative funds, such as absolute-return funds, which generally have a low equity exposure.

“People don’t understand that, though they feel good because they haven’t lost capital, they’re not seeing the long-term picture which shows that they have lost money in the sense that they have lost time that could have been used to grow their capital,” Van der Mescht says.

He says inflation-targeting funds have been easy for financial intermediaries to sell because of the high level of risk aversion among their clients and because “people have learnt from experience not to jump into the market after a 30% run”.

Van der Mescht believes people are invested too conservatively. “They won't have enough money to take early retirement — you need equities in your portfolio for real growth”.

He said that after the market crash of 2000/01 people lost money by selling their investments too late, after the market had fallen, and many have been reluctant to re-enter the market.

Van der Mescht said this financial behaviour meant that on a compound basis these investors “have lost even more by staying out of the markets”.

Research by Sanlam Collective Investments shows that the JSE has rebounded after every crash within a few years. From standing at just under 8000 points after the recent technology stocks meltdown, the All-Share index has now moved past 16000.

Being conservatively invested comes back to the advice you get from your financial intermediary, who must assess your risk profile and financial needs.

“Being conservative is fine if your need analysis shows that that is what your requirements are, but if it’s because of your investment behaviour then it’s totally wrong,” Van der Mescht says.

For investors who can’t afford to risk the volatility of the stock market there are smarter options than having all their funds in the money market, he says.

Van der Mescht says that, in exchange for taking a little more risk, even very conservative investors could get much better returns from inflation-linked funds, which are mandated not to lose money over a
12-month period.

Sanlam’s research shows that, after tax, your returns from inflation-linked funds could be as much as three times higher than those you would get from the money market.

Arno Lawrence, head of fixed-interest investments at Old Mutual Asset Managers (Omam) SA, said at an investment conference this week that if an investor could not accept an unpredictable income, then income funds were the right place for them.

But, he says, if you are prepared to take on some volatility in the income you receive, enhanced-income funds are a much better buy — especially if you have a long-term investment horizon — because their distributions increase over time.

Peter Brooke, Omam’s equity strategist, said it was crucial that investors learn that they are likely to get lower returns in future, from about 7% from cash investments up to about 13% from equities.

He said that “in the long term equities will outperform other asset classes” but, he lamented, investors simply “don’t own enough shares”. Interestingly, for those who have most of their investments in cash, Brooke said there was “not such a big gap between the after-tax yield on shares and on cash to justify the risk of holding shares”.

He said the growth shares offer is crucial because of increasing longevity. About 36% of people aged 60 today will live until they’re 90, compared to only 16% in the 1980s.

Dividend yields on the South African market are now at about 3%, he said and, unlike distributions from bonds, dividend yields grow over time and soon overtake the initial yield you get on cash.

He said people had to be convinced that they should invest for longer “which they should be doing anyway — because your dividends will grow and beat [the returns from] cash and bonds within a short time”.

There are, of course, short-term risks, though these should not deter the long-term investor.

“Right now it’s the foreign players buying South African stocks, which has driven our market very high,” he said — the JSE returned 20% in the September quarter alone. “The problem is, this money can go out of the country just as quickly.”

However, Brooke said “90% of share-price movements are meaningless noise and, in the long term, shares beat other assets”.

Article by: Chris Needham - www.sundaytimes.co.za