It has been a tough time for South African investors, especially over the past year.
The JSE All Share Index (ALSI) is down almost 9% over the period. Investors with more growth-oriented objectives also experienced low returns from listed property, after almost two decades of exceptional returns. It has been a particularly tough year, with listed property down 17%.
What makes the current market conditions even tougher for local investors is the fact that they come after an extended period of low returns from markets. The JSE has been in a sideways trend since September 2014.
This trend has also been characterised by high volatility, and a series of high-profile events at a political and corporate level. Investors have been battered by the surprise firing of then-finance Minister Nhlanhla Nene, followed by various state capture revelations, credit downgrades, technical recessions, numerous cabinet reshuffles, increasing unemployment, increasing administered prices, rising petrol prices, a volatile currency, a hike in the VAT rate, deteriorating Emerging Market fundamentals, trade wars, Steinhoff, MTN, Resilient… the list goes on.
In the face of such a barrage of bad news, it is becoming increasingly difficult for investors to keep a cool head, and think rationally about their investments.
So what now?
Investing is an inherently complex activity, and therefore requires a sophisticated approach that looks beyond what is happening now and what has happened recently.
It is complex because the future is always uncertain, markets are complex adaptive systems, not all risks can be predicted or even identified, and there are a host of market players all with differing views and intentions.
This is compounded by the fact that money itself is a highly emotive thing. Usually rational people have been known to become highly irrational when it comes to their own money. Retired investors with a lot of time on their hands on a day-to-day basis struggle immensely at times like these, when their pensions (quality of life in retirement) seem to be under threat.
When it comes to dealing with complex and emotionally charged situations, it is important that investors go back to tried-and-trusted, long-term principles. They should review their investments and ensure they are applying these principles.
The first principle is diversification.
Simply put, diversification is about not having all your eggs in one basket. It is about investing in a range of different asset classes (shares, bonds, property, cash, hedge funds, S12J); domiciles (emerging markets, developed markets); strategies (value, growth, momentum, income growth, total return); and products (unit trusts, endowments, ETFs, tax free investments, retirement annuities).
By combining uncorrelated assets in a portfolio, investors will be able to reduce portfolio risk, without necessarily giving up expected return.
The table below shows the historical performance of balanced and flexible funds. These are diversified funds, which largely cater for retirement and discretionary investors respectively. Unsurprisingly, they have done better in these difficult market conditions than equities and listed. All performance data has been sourced from Profile Media's Fund Analytics.
The second enduring principle is having a long-term mindset and perspective.
In 1974, sociologist Dr. Edward Banfield of Harvard University wrote a book titled The Unheavenly City. He described one of the most profound studies on success and priority setting ever conducted.
Banfield's goal was to find out how and why some people became financially independent during the course of their working lifetimes. He finally concluded that the major reason for success in life was a particular attitude of mind. Banfield called this attitude long time perspective.
Time perspective referred to how far you projected into the future when you decided what you were going to do or not do in the present. This attitude of a long time perspective is often found in successful entrepreneurs and executive managers in large corporations. The ability to take a long time perspective sometimes leads to decision-making that does not make sense to outside observers.
The book The Outsiders by William Thorndike is about eight CEOs that achieved phenomenal results for investors over an extended period. It looks closely at the investment decisions made by these CEOs, and the impact on subsequent share price performance.
These CEOs often made decisions that baffled market commentators, as they contradicted market trends and conventional thinking in many instances.
Thorndike notes on page 209: "Although the outsider CEOs were an extraordinarily talented group, their advantage relative to their peers was one of temperament, not intellect."
The final principle that is important in these market conditions is one of managing leakage.
In a low-return environment, funds and investment products with high-fee structures may struggle to deliver positive returns on an after-fee basis. However, it is important to bear in mind that fees are not the only consideration for investors.
The graph below shows the performance of a number of index tracking balanced funds, since inception of the youngest fund in the group (10x High Equity). Included in the graph is the Allan Gray Balanced fund, which is significantly more expensive than all of the index balanced funds. The performances below are net of fund fees.
The relatively expensive fund has outperformed all the cheap funds net of their higher fee, confirming the point that fees alone are not the only consideration. There is also a significant dispersion in returns between the various index tracking balanced funds themselves.
Best performer over the period (Prescient Balanced) outperformed the worst performer (10x High Equity) by 7.1% over the period. That is more than a 2% per annum difference in return, and there's less than a 0.50% p.a. difference in fees.
Investors should be cautious not to get sucked into the aggressive cheaper is always better messaging, because it is certainly not. A well-balanced portfolio at a relatively cheap price will serve investors well over time.
Interestingly, all the index balanced funds outperformed the balanced fund sector average (SA-Multi Asset-High Equity) over this period, affirming the point that fee management in a low-return environment is important.
The other area of leakage is that of tax. The typical response from investors is to run for the safety of money market and bank type investments. While these are great at protecting capital in the short term, their returns are highly inefficient from a tax perspective. The table below shows the net of tax return for an investor who pays income tax at the highest marginal rate of 45%.
Revisit your portfolio
While we advocate for investors to remain invested through these trying times, it is important that investors still take some action.
The action we encourage is for them to revisit their portfolios to ensure that they are indeed implementing sound long term investment principles. Investors will do well to engage the services of a suitably experienced and qualified independent adviser who can assist in this process.
* Craig Gradidge is an Investment and Retirement Planning Specialist at Gradidge Mahura Investments.
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