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.
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.