Lock­ing in re­turns – or lock­ing out growth?

Flex­i­ble fixed in­come funds of­fer a num­ber of advantages over money-mar­ket funds. Here is why in­vestors should con­sider this op­tion.

Finweek English Edition - - FUNDFOCUS - Paul Hutchin­son is sales man­ager at In­vestec As­set Man­age­ment.

are­cur­ring ques­tion from many po­ten­tial in­vestors is, “I am in­vested in a one-year fixed de­posit earn­ing north of 8%. This is the same as the cur­rent two-year fixed rate of­fered by the RSA Re­tail Sav­ings Bond. Why then should I risk my hard-earned cap­i­tal by in­vest­ing in the broader mar­ket, es­pe­cially as as­set man­agers have been cau­tion­ing in­vestors to ex­pect lower fu­ture re­turns from all as­set classes?” This is an im­por­tant ques­tion and here are some key points to con­sider.

The ben­e­fits of a broad and flex­i­ble in­vest­ment man­date 1. Po­ten­tial out­per­for­mance

While a guar­an­teed re­turn of 8% is at­trac­tive, there are a num­ber of rea­sons why con­ser­va­tive in­vestors could con­sider in­vest­ing in a flex­i­ble fixed in­come fund, such as the In­vestec Di­ver­si­fied In­come Fund. The broad in­vest­ment op­por­tu­nity set and flex­i­bil­ity of the fund’s in­vest­ment man­date mean that the fund has the po­ten­tial to out­per­form 12-month cash re­turns on a one-year ba­sis. This has been the case his­tor­i­cally.

The fund has out­per­formed 12-month cash ap­prox­i­mately 74% of the time over this pe­riod by an av­er­age of 1.63% p.a. This sup­ports the fund’s unique “pro­tect­ing and par­tic­i­pat­ing” in­vest­ment strat­egy, through which it seeks to de­liver at least cash-like re­turns when bonds un­der­per­form and at least 30% of the bond re­turn when bonds out­per­form.

Fur­ther­more, while an out­per­for­mance of 1.63% p.a. may not seem like much, the ben­e­fits of com­pound­ing this ad­di­tional re­turn over time are sig­nif­i­cant. As il­lus­trated in the graph, in only seven years, the 1.63% p.a. out­per­for­mance of the fund al­ready amounts to R177 000 or 11.2%.

The fund has the flex­i­bil­ity to in­vest in lon­gand short-dated govern­ment and/or cor­po­rate bonds, in­fla­tion-linked bonds, prop­erty loan stocks, deben­tures, fixed de­posits, pref­er­ence shares and listed prop­erty. This de­liv­ers a unique and ben­e­fi­cial out­come to in­vestors look­ing for a low-risk, real-re­turn so­lu­tion. It also sig­nif­i­cantly re­duces the risk of be­ing in­vested with one coun­ter­party.

2. Im­me­di­ate ac­ces­si­bil­ity at no cost

In­vestors also have im­me­di­ate ac­cess to their money, as op­posed to lock­ing it in for 12 months. Early with­drawal penal­ties are charged on ac­cess­ing fixed de­posit in­vest­ments prior to ma­tu­rity. And, given the un­cer­tain po­lit­i­cal, eco­nomic and in­vest­ment en­vi­ron­ment, the de­ci­sion to lock up money at a fixed rate may prove riskier than in­vestors re­alise.

3. Neg­a­tive real re­turns

While in­fla­tion may al­ready have peaked, it is likely to re­main at the up­per end of the South African Re­serve Bank’s tar­get range of 6%, in­ter­nal and ex­ter­nal shocks not­with­stand­ing. There­fore, a key con­sid­er­a­tion for in­vestors in the money mar­ket is the pos­si­bil­ity that af­ter tax they re­alise a neg­a­tive real re­turn, i.e. a de­te­ri­o­ra­tion in the pur­chas­ing power of their money/liv­ing stan­dards, should in­fla­tion rise sharply un­ex­pect­edly.

The im­por­tance of stay­ing in­vested

There is much ev­i­dence in sup­port of stay­ing in­vested. As an ex­am­ple, Amer­i­can re­search com­pany Dal­bar has been mea­sur­ing the ef­fects of in­vestor de­ci­sions to buy, sell and switch into and out of mu­tual funds (US unit trusts or col­lec­tive in­vest­ment schemes) over both long- and short-term time frames (see Dal­bar’s 21st An­nual Quan­ti­ta­tive Anal­y­sis of In­vestor Be­hav­ior). The re­sults con­sis­tently show that the av­er­age in­vestor earns less – in many cases, much less – than fund per­for­mance re­ports would sug­gest. This is sim­ply be­cause of self-de­struc­tive in­vestor be­hav­iour – sell­ing out of funds when their per­for­mance bot­toms and buy­ing into funds when their per­for­mance peaks.

Long-term in­vestors cur­rently in­vested in the mar­ket are there­fore en­cour­aged to re­main in­vested and not be swayed by short-term noise. In ad­di­tion to the points made ear­lier, dis­in­vest­ing may trig­ger a cap­i­tal gains tax event, while de­fer­ring the in­vest­ment de­ci­sion 12 months hence also in­tro­duces rein­vest­ment risk. (The lat­ter refers to the risk that in­vestors will be forced to rein­vest at a lower rate, in an in­vest­ment en­vi­ron­ment with lower-yield­ing al­ter­na­tives.)

Dal­bar con­cludes that, “No mat­ter what the state of the mu­tual fund in­dus­try, boom or bust: In­vest­ment re­sults are more de­pen­dent on in­vestor be­hav­iour than on fund per­for­mance. Mu­tual fund in­vestors who hold on to their in­vest­ments have been more suc­cess­ful than those who try to time the mar­ket.”

The value of in­de­pen­dent in­vest­ment ad­vice

We believe that for most in­vestors in­vest­ing in the money mar­ket, in­clud­ing a one-year fixed de­posit is not a vi­able long-term in­vest­ment, since re­turns are only likely to match in­fla­tion at best. As al­ways, given the im­por­tance of mak­ing the cor­rect de­ci­sion, we strongly rec­om­mend that in­vestors seek pro­fes­sional in­vest­ment ad­vice, tai­lored to their in­di­vid­ual cir­cum­stances.

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