Po­si­tioned for in­fla­tion-beat­ing re­turns

With its tar­get of in­fla­tion plus 5%, the Pru­den­tial In­fla­tion Plus Fund is a good op­tion for in­vestors who are af­ter more than a cash re­turn.

Finweek English Edition - - FUND FOCUS -

afund that we have reg­u­larly fea­tured as a favourite among re­tirees over the years is the Pru­den­tial In­fla­tion Plus Fund, which con­tin­ues to be a pop­u­lar choice among in­vestors. With R38bn un­der man­age­ment, it has re­turned a nom­i­nal an­nu­alised 13.1% since in­cep­tion 15 years ago. Its pri­mary aim is to out­per­form in­fla­tion by 5% be­fore fees and, as a sec­ondary goal, to re­duce the risk of cap­i­tal loss over any 12-month rolling pe­riod. In­fla­tion has av­er­aged around 6% per an­num.

“It’s a fund that de­liv­ers on both of its man­dates con­sis­tently,” ex­plains Pi­eter Hugo, man­ag­ing di­rec­tor of Pru­den­tial Unit Trusts. “It gives clients a much smoother ride than they’d get in a typ­i­cal bal­anced or eq­uity fund, while at the same time de­liv­er­ing very de­cent in­fla­tion­beat­ing re­turns. It has also con­sis­tently fea­tured in the top quar­tile of its Asisa peer group since its in­cep­tion 15 years ago.”

A typ­i­cal bal­anced fund av­er­ages about 60% in eq­ui­ties over a cy­cle, whereas the In­fla­tion Plus Fund av­er­ages about 36%, he points out. “A bal­anced fund nat­u­rally de­liv­ers greater growth over time, but its per­for­mance is a lot more volatile.

“So clearly, for a client able to stom­ach higher volatil­ity, a bal­anced fund might be more suit­able. But the In­fla­tion Plus Fund is sig­nif­i­cantly prefer­able for some­one seek­ing more than a cash re­turn. In­fla­tion plus 5% is ac­tu­ally an ag­gres­sive tar­get for a fund with a max­i­mum limit of 40% in eq­ui­ties, but it has ef­fec­tively reached its re­turn tar­get 77% of the time, which is a su­perb hit rate.”

Hugo notes, how­ever, that in­fla­tion-plus-type funds have un­der­per­formed their bench­marks due to the poor re­turns from many as­set classes in the past two years, es­pe­cially do­mes­tic eq­ui­ties. Many clients are com­fort­able in cash, given the rel­a­tively high in­ter­est rates of around 8% on of­fer.

“In­vestors may be get­ting im­pa­tient with un­der­per­for­mance, but now is the wrong time to switch to cash, es­pe­cially since we are likely near or at the peak in in­ter­est rates,” he ex­plains. “Cash has re­turned more than eq­ui­ties for two con­sec­u­tive years now (2015 and 2016), so it’s very un­likely that this would be re­peated in 2017. Over the long term, cash of­fers in­fla­tion plus 1%, so in­vestors would be bet­ter off to stay put in in­fla­tion-plus funds.”

Hugo be­lieves that, on bal­ance, the In­fla­tion Plus Fund is well-po­si­tioned to meet its re­turn tar­get over the medium term. The fund cur­rently com­prises 23% SA eq­uity, 21% SA nom­i­nal bonds, 19% SA in­fla­tion-linked bonds, 13% for­eign eq­uity, 9.7% listed prop­erty, 6.7% for­eign bonds, 4.9% for­eign cash, 2.1.% SA cash, and 1% off­shore prop­erty.

He says the Pru­den­tial in­vest­ment team is more up­beat in its out­look for SA eq­ui­ties than it has been for the past two years. “We have marginally re­duced ex­po­sure in off­shore eq­ui­ties and switched the money to lo­cal eq­ui­ties. Off­shore eq­ui­ties have run very hard over the past five years.

“We’ve been over­weight SA govern­ment and cor­po­rate bonds for more than a year, with SA bonds hav­ing been the best-per­form­ing as­set class in 2016. True, it did come with an el­e­ment of risk, with in­vestors hav­ing stayed away from them for fear of a sov­er­eign down­grade. How­ever, we be­lieved that this risk was priced into the mar­ket, and there’s still up­side po­ten­tial. Be­sides, nom­i­nal bonds have been yield­ing up to 9% in­come.

“The team also recog­nises some value in listed prop­erty rel­a­tive to in­fla­tion­linked bonds, and although the lat­ter look some­what ex­pen­sive, the fund con­tin­ues to hold a sig­nif­i­cant pro­por­tion due to the in­fla­tion pro­tec­tion it pro­vides in line with the fund’s in­fla­tion-linked per­for­mance tar­get.”

The Pru­den­tial in­vest­ment team is more up­beat in its out­look for SA eq­ui­ties than it has been for the past two years.

Cau­tion around chas­ing short-term fund per­for­mance

Hugo is con­cerned that too many in­vestors are re­luc­tant to ride out a fund’s mar­ket cy­cle – in this case in­fla­tion-plus funds – be­ing eas­ily tempted to fol­low short-term per­for­mance and switch be­tween funds, de­stroy­ing in­vest­ment value in the process.

In­ter­est­ingly, Pru­den­tial re­cently con­ducted a com­par­a­tive anal­y­sis be­tween short-term fund per­for­mance and net in­vest­ment flows, and dis­cov­ered that the two are closely linked. Cap­i­tal in­flows tend to be strong­est dur­ing the lat­ter stages of a fund’s up­ward mo­men­tum, with out­flows quickly fol­low­ing de­clin­ing rel­a­tive short-term per­for­mance.

“Even if a fund is a con­sis­tent top per­former over longer pe­ri­ods of three, five or 10 years, flows closely fol­low the most re­cent one-year per­for­mance,” he points out. “In­vestors aren’t choos­ing their funds based on longert­erm per­for­mance, which goes against the most ba­sic in­vest­ment tenets.”

Hugo says the an­swer is to do your home­work and iden­tify a fund whose man­date meets your in­vest­ment ob­jec­tive, is man­aged by a sound as­set man­ager and has a strong track record over five years or longer. This in­di­cates that a man­ager can get it right through mar­ket cycles. Then, in­vest in it and stick with it for the ap­pro­pri­ate amount of time to give it the best chance of de­liv­er­ing on its man­date. Man­ag­ing Di­rec­tor of Pru­den­tial Unit Trusts

Pi­eter Hugo

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