To many potential investors, deciding when, where and in which financial products to invest is a complex and daunting task. It need not be the case.
Whether you are a seasoned investment specialist who analyses the markets daily, or a passive investor who glances through a quarterly investment report, the dynamics of the investment world stay the same. Investing should not be a gamble.
It is a long-term endeavour with set goals, and should start with an honest self-appraisal by the investor.
“The investor’s timeframe is very important,” says Jean Pierre Verster, founder of Protea Capital Management. “The investor needs to know how long his or her investment horizon is.”
Put simply, this means determining for how long a certain amount of money needs to be invested. If it is less than five years, the investment should be parked in an asset that shows less price volatility; if more, the investor should appraise his or her appetite for volatility, or risk.
Also important is the reason for saving. “An investor’s investment objective determines the asset mix,” explains Craig Pheiffer, chief investment strategist at Absa Stockbrokers and Portfolio Management.
Three broad asset classes are available to an investor with excess cash: equities (or shares), fixed-income products, and cash.
Shares, stocks or equities are synonyms; all refer to ownership in a company with the right to receive a dividend, if declared. Holders of shares also have the right to vote on company-related matters that are regulated by the Companies Act.
Equities are traditionally the most volatile and risky form of investment asset.
They are, however, a crucial part of any long-term mix of investments, also referred to as an investment portfolio. Age-old wisdom holds that equities should return, through capital growth and dividend payments, more money than inflation is able to consume.
“An investor who is comfortable with volatility should include equities, also known as shares or stocks, in his or her portfolio. The proportion of equities in a portfolio is linked to the investor’s investment horizon,” says Verster.
In other words, the longer you intend to leave your invested money to grow, the higher the proportion of equities should be.
The next question to ask is: how do I invest my cash in equities? Here, it’s necessary to distinguish between so-called active and passive investment strategies.
This, says Verster, means asking: “Is there a human being involved in managing a fund or not?”
In active fund management, a fund manager decides where capital should be employed; in passive funds, such as exchange traded funds (ETFs), investment decisions are made according to a set rule, such as the size of the company.
Fund managers are trained and experienced navigators of the investment world, using their knowledge and analytical skills to determine where to invest on behalf of fund members.
Traditionally, unit trusts, or to use their legally correct name, collective investment schemes, have been the main investment destination for retail investors. When an investor
buys into a unit trust fund, he or she is issued with units.
The unit trust fund, guided by its fund manager, invests in assets, including equities, bonds and cash, for the benefit of the unit holders. This is the active approach.
ETFs, in contrast, are listed and traded directly on the stock exchange. According to Pheiffer, they are as secure as unit trusts, as the assets are held in trust.
Pheiffer advises investors to place some of their savings offshore. This can be achieved in several ways: by selecting local unit trust funds denominated in rands that invest offshore; by physically transferring money overseas and investing in products offered in other countries; or by buying so-called locally listed rand-hedge equities.
The South African government prescribes that a maximum of 30% of retirement savings, stored in a retirement annuity, pension or provident fund, can be shifted overseas. In addition, South Africans can remove R10 million in capital per year and R1 million in discretionary cash overseas.
South African fund managers offer a wide range of offshore unit trusts to local investors. Potential investors are strongly advised to consult a registered financial adviser before deciding on an offshore investment.
Fixed income and cash
Investors with a smaller appetite for risk, especially those whose investment horizon is short, should consider a fixed-income asset or cash.
“Fixed-income assets are less volatile investments,” says Verster.
“Cash, such as a bank deposit, is the safest type of investment, because your capital value doesn’t fluctuate at all.”
Unit trusts invested in bonds, which are issued by both government and companies, return a ‘yield’. Bonds are issued to investors with the promise to repay the capital at a specific future date, which can range from three months to thirty years in the future.
The issuer of the bond also promises to pay a ‘coupon’, or interest, at regular intervals, usually twice a year.
Bonds return a little more than cash, but, in the long term, they generally don’t do as well as equities. Over the past five years, however, bonds have returned more than even the best-peforming equities in South Africa due to international and local headwinds faced by domestic companies.
Cash, traditionally the safest form of investment, is usually parked in money market funds or similar investment products. Their returns match, or are slightly better than, interest rates at commercial banks.
South Africa’s hedge fund industry is strictly regulated in much the same way as traditional unit trusts. Hedge funds are not a homogenous group of funds; they vary significantly in their investment strategies, says Verster.
Equity long-short funds traditionally constitute the most well-known type. Simply put, the managers of these funds buy company shares that they think will rise in price, and short-sell those stocks that they think will decline, he explains.
To ‘short’ a stock is to borrow shares from a holder of shares, at a marginal cost, and sell them on the market in the hope that the share price will decline.
In time, and after the share price has dropped, the fund manager buys the shares back cheaper on the market and returns them to the lender. The difference in share price, less the cost to borrow and other transaction costs, is his or her profit.
This may sound risky, but, as Verster points out, laws regulating South African hedge funds strictly govern the risks that hedge fund managers are allowed to take.
Leave investing to the specialists
Before deciding to wade into the realm of investments, a potential investor should discuss investment objectives with a registered financial advisor, advises Pheiffer.
“If you don’t have time to watch the markets all day, rather invest in managed products,” he advises.