CAN YOUR IN­VEST­MENTS PAY YOUR BILLS?

Finweek English Edition - - FRONT PAGE - BY KRISTIA VAN HEER­DEN

Over the past 10 years, inf la­tion rose 6.1% per year. Be­tween Septem­ber 2004 and Septem­ber 2014, t he Con­sumer Price In­dex (CPI) rose by a to­tal of 81%.

Un­less your in­come also rose by 81% over the same pe­riod, odds are you’ve had to give up a few lux­u­ries. You’ve prob­a­bly also started say­ing things like, “In my day we only paid R4 for a litre of petrol!”

The CPI t r acks t he prices of con­sumer goods and ser­vices and is com­prised of a num­ber of sub-in­dices track­ing items like food, petrol and ser­vices. Com­bined, they rep­re­sent how much it costs to live in South Africa. Says Alex Funk, head of as­set con­sult­ing at GCI As­set Man­age­ment: “The av­er­age con­sumer con­sid­ers inf la­tion to be far more than the re­ported CPI fig­ures and, to be per­fectly hon­est, they are cor­rect.”

For ex­am­ple, in Au­gust the CPI fig­ure for food price in­fla­tion was 6.4%, while the regis­tered in­fla­tion was 9.4% −a 3% in­fla­tion pre­mium that hits lo­cal con­sumers where it hurts most.

Bleak though the inf la­tion fig­ures might be, there is still hope in the free mar­ket. The JSE All Share In­dex (Alsi) grew by 16.3% per year over the same pe­riod, rep­re­sent­ing a to­tal growth of 353%. If you in­vested the equiv­a­lent of your monthly ex­penses in the Alsi ev­ery month for the past 10 years, you would prob­a­bly be spend­ing less time hark­ing back to the good old days and more time drink­ing cham­pagne.

THE LIFE­STYLE HEDGE PORT­FO­LIO

With inf la­tion tight­en­ing its grip on house­hold bud­gets on the one hand and the JSE con­tin­u­ing to de­liver great re­turns on the other, should your in­vest­ment strat­egy place a greater fo­cus on hedg­ing against or­di­nary life­style ex­penses like food, cloth­ing

and ed­u­ca­tion? Al­wyn van der Merwe, di­rec­tor of in­vest­ments at San­lam Pri­vate Wealth, thinks so.

“The pri­mary and generic rea­son for in­vest­ing is to grow your pur­chas­ing power over time. In other words, to hedge against inf la­tion,” he says. His col­league, in­vest­ment an­a­lyst Re­nier de Bruyn, agrees, adding that inf la­tion slowly erodes the pur­chas­ing power of cash sav­ings.

“Hedg­ing in­volves re­duc­ing the risk of ad­verse price move­ments in an as­set, there­fore tak­ing an off­set­ting po­si­tion in a re­lated as­set. Hedge in­vest­ing there­fore in­volves pur­chas­ing an as­set to pro­tect one­self against a ris­ing cost. The closer the fit be­tween the two, the bet­ter the hedge will be,” ex­plains 2014 FPI Fi­nan­cial Plan­ner of the Year Peter Hewett. He says that cou­pling life­style cost vo­latil­ity to com­pa­nies as­so­ci­ated with that life­style is not a new con­cept.

“In 1987, the price of a one-carat di­a­mond was $6 000. By 2014, the price had in­creased to $12 700, a 112% re­turn over the pe­riod. If one had in­vested the same amount of money into Tif­fany & Co. shares, it would be worth $312 500 in 2014, a re­turn of over 5 000%. Who said a di­a­mond was a girl’s best friend?” he jokes.

“Many in­vestors f ind com­fort in a strat­egy like this due to the psy­cho­log­i­cal dy­nam­ics caused by the tan­gi­ble link be­tween an iden­ti­fied ex­pense and the as­set price off­set­ting it. It also cre­ates dis­ci­pline in the sense of long-term in­vest­ing due to the un­der­ly­ing driv­ers of the two prices be­ing more closely linked.

“If you are in a po­si­tion to pur­chase a bas­ket of shares across the many sec­tors and in­dus­tries that di­rectly and in­di­rectly im­pact on the cost of liv­ing, this would pos­si­bly be a rea­son­able strat­egy be­cause you would end up with a very di­ver­si­fied port­fo­lio,” he adds.

Sonia du Ple ss i s , a ce r t i f i e d fi­nan­cial plan­ner at Bren­thurst Wealth man­age­ment, says buy­ing a stock to hedge against inf la­tion is a good con­cept only if the company is a good one. “One has to look at the share it­self. It needs to be able to add value and needs to be a good buy,” she ex­plains. She adds that in­vest­ing for a pe­riod of at least 10 to 15 years is im­per­a­tive in cre­at­ing a suc­cess­ful life­style hedge port­fo­lio.

The div­i­dend yield of most of the com­pa­nies listed be­low beat in­fla­tion over the past 10 years, but De Bruyn warns that the div­i­dends of th­ese com­pa­nies don’t al­ways cor­re­late per­fectly with the un­der­ly­ing in­fla­tion.

“Nev­er­the­less, I like the think­ing be­cause it forces in­vestors to fo­cus on the un­der­ly­ing cash f lows of the com­pa­nies, as op­posed to just the share prices, and con­sider the im­pact of in­fla­tion on their sav­ings.”

NOT A PER­FECT STRAT­EGY

If past be­hav­iour were a pre­dic­tor of

fu­ture be­hav­iour, putting to­gether a life­style hedge port­fo­lio based purely on the div­i­dend yield of th­ese com­pa­nies would be a no-brainer. Un­for­tu­nately − try as we may − no­body can pre­dict the mar­ket and many there­fore warn against this method of in­vest­ment.

Hewitt says that the chal­lenge lies in dif­fer­en­ti­at­ing be­tween mul­ti­ple com­pa­nies pro­vid­ing sim­i­lar ser­vices. He agrees with Du Plessis that a bet­ter strat­egy is to invest in a qual­ity company that is well-priced and hang­ing on to the in­vest­ment over a pe­riod to cap­i­talise on com­pound­ing. “In­vest­ing in qual­ity busi­nesses and giv­ing them time to grow is a far su­pe­rior strat­egy,” he says.

Funk finds the con­cept of a life­style hedge port­fo­lio too sim­plis­tic. Firstly, he says, inf la­tion pres­sures on com­pa­nies such as Sho­prite and Pick n Pay arise from pro­ducer in­fla­tion and is most of­ten the re­sult of the ris­ing cost of raw ma­te­ri­als. Be­cause re­tail­ers avoid pass­ing on th­ese in­creases to con­sumers im­me­di­ately for fear of los­ing cus­tomers, it could take over six months for the pro­ducer inf la­tion to re­flect in the spend­ing of con­sumers.

“The use of such stocks as a hedge strat­egy would re­quire the con­sumer to have a longer in­vest­ment time frame. Ul­ti­mately, it will re­sult in an im­per­fect hedge strat­egy as con­sumers will still have to fund the cost deficit for at least six months,” he says.

His sec­ond ob­jec­tion to the con­cept of a life­style hedge port­fo­lio has to do with the com­plex­ity of a company’s share price. He says that fac­tors like debt-to-eq­uity ra­tios, op­er­at­ing ex­pense anal­y­sis, di­rec­tor deal­ings, the role of man­age­ment and cor­po­rate gov­er­nance as well as the eco­nomic en­vi­ron­ment can have a ma­te­rial im­pact on the share price move­ment, not just price in­fla­tion.

“Thirdly, an ex­ten­sive break-even anal­y­sis would have to be con­structed to in­di­cate the amount of shares needed to per­fectly off­set the rise of in­fla­tion and the ef­fect it will have on the con­sumer’s monthly dis­pos­able in­come,” he adds.

The con­sumer would have to an­a­lyse her ex­ist­ing monthly dis­pos­able in­come at the cur­rent rate of inf la­tion. An as­sump­tion would then have to be made on the ex­pected inf la­tion for a pe­riod of six months to a year, after which she would have to cal­cu­late to what ex­tent the inf la­tion in­crease would im­pact her cur­rent monthly dis­pos­able in­come.

Fi­nally she would have to as­sess the as­sumed share price in­crease and num­ber of shares re­quired to match the de­crease in monthly dis­pos­able in­come after con­sid­er­ing all costs, in­clud­ing bro­ker­age fees. This would have to be an ex­act match for the hedge strat­egy to be per­fect.

“Con­sumers can ben­e­fit far more fi­nan­cially by cre­at­ing an op­ti­mal re­tire­ment plan, stick­ing to the plan and invest- ing as­sets in a broad range of as­set classes, coun­tries and as­set man­agers, rather than try­ing to ex­ploit com­pli­cated strate­gies to gain fi­nan­cial wealth,” he con­cludes.

AL­TER­NA­TIVE PLAYS

Yusuf Wadee, head of Ex­change Traded Prod­ucts at RMB, says that in­vestors have to take a long-term view and invest in a num­ber of shares to get a bet­ter rep­re­sen­ta­tion of the mar­ket.

“It is far less likely for a col­lec­tion of shares to be af­fected by a bad set of in­di­vid­ual company re­sults,” he ex­plains. “In ad­di­tion, hold­ing a bas­ket of shares across a di­verse set of com­pa­nies is more likely, over time, to pro­tect against in­fla­tion, which is mea­sured over a broad bas­ket of goods and ser­vices.”

He says other fi­nan­cial in­stru­ments, such as in­fla­tion-linked bonds, are more closely linked to CPI. “Hold­ers of th­ese bonds earn re­turns which are ex­tremely close to inf la­tion for the du­ra­tion of their in­vest­ment. Th­ese bonds are fre­quently used by pro­fes­sional in­vestors to hedge out their fu­ture in­fla­tion-linked com­mit­ments and li­a­bil­i­ties.”

He rec­om­mends prod­ucts like RMB’s Inf la­tionX ETF, which are linked to the value of th­ese bonds and per­fect for in­vestors look­ing for inf la­tion-linked re­turns to hedge against their per­sonal, and ever-in­creas­ing, cost of liv­ing.

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