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.
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