- Uncertainty is a Certainty
- Don’t just do something, stand there!
- Income is not wealth
- Regulating Crowdfunding in South Africa
Just 88 days into the New Year President Jacob Zuma announced a major cabinet reshuffle, prompting a surprisingly quick downgrade from ratings agency S&P Global Ratings (S&P).
In one week the rand dropped from R12,40 to the US dollar to R13,75.
If 2016 was a year of improbable probables, 2017 is about certain uncertainty.
It is not just South Africa feeling the effects of an uncertain world. Political uncertainty, rising populism and policy divergence will continue to dominate markets globally in 2017.
So how do investors navigate these unpredictable times? One of the best ways is to ensure your investment portfolio is sufficiently diversified across uncorrelated assets. This could mean diversification across the asset classes – equities, bonds and cash, property and alternative investments such as private equity – and diversification across geographies or diversification across risk, asset managers or investment styles.
When the going gets tough in South Africa, investors tend to want to move their money offshore in a knee-jerk reaction. Since the 1970s, the rand has lost over 90% of its value against the dollar in nominal terms. Following the cabinet reshuffle, the rand quickly went from being the best performing emerging market currency in the year up until 24 March to the worst performer since 24 March.
It would come as no surprise then that most people would list hedging against further currency depreciation as one of the greatest benefits of investing offshore.
But a weak rand is only a part of a broader consideration. Investors should be looking at a broad range of benefits provided by offshore investments.
Consider the South African equity and bond markets relative to the rest of the world. South Africa represents a mere 0,2% of global debt indices with only 60 securities out of 20 708 in the broader Barclays Multiverse index, and our GDP is just 0,51% of the world’s economy. When viewed in this context, it becomes clear a home bias limits what you can invest in.
If diversification has been a productive strategy for a nation whose stock markets represent half the globe’s market capitalisation – the United States – how much stronger is the argument for South African investors, where the JSE is a mere 0,63% of the investable universe?
Spreading assets across several countries as well as accessing opportunities in sectors and companies which may not be available locally (such as the depth of technology companies available to American and European investors) makes sense.
The trade-off between risk and reward suggests that being conservatively invested is an optimal strategy; at least until there is more policy certainty and the recent ratings downgrades have been fully-priced into the financial markets. This would suggest a higher percentage of short-dated fixed income assets, supplemented by a relatively large holding of offshore assets and a bias within the equity sector towards the large industrial companies that have relatively well diversified sources of earnings.
In a volatile environment, there are always wealth-building opportunities.
South African equities
A country-specific event such as a credit ratings downgrade can make components of the South African equity market attractive. The constituents of the JSE All Share Index have changed significantly over the past decade. The large resource stocks and rand hedge counters now make up almost 70% of the index, which benefits from a weakening rand and stronger commodity prices.
By taking an active approach to valuations and returning to fundamentals, there are still opportunities for stock picking in this environment. Some of these opportunities can be found in resources due to recent price recoveries. Financials, which were looking attractive based on rate cut expectations locally, now warrant a ‘wait and see’ stance based on the likelihood of increasing rather than decreasing interest rates following the downgrade.
The improving global outlook implies investors can consider increasing equity exposure globally.
Despite ongoing, and especially the most recent, market volatility, this year promises to be an interesting and rewarding one for equity investors with ample stock-picking opportunities.
The asset class posted great returns in 2016, with the All Bond Index returning 15,4% for the year and still enjoying a solid start to 2017 that was only curtailed by the political noise created by the replacement of the Finance Minister in the cabinet reshuffle. Prior to the changes which led to the country being downgraded by two rating agencies to sub-investment grade the interest rate backdrop was looking benign as the local currency strengthened to R12,31.
The downgrade could lead to a sell-off of some rand-denominated government bonds, leading to an increased cost of funding for corporates, parastatals and government. However, higher bond yields could also attract foreign investors in search for better returns than those offered in developed markets.
The 10-year (R186) South African government bond yield moved from a low of 8,25% at the end of March to touch a high of 9,15% on Monday, 3 April following South Africa’s credit-rating downgrade announcement. This means the cost of borrowing has increased for the South African government.
In this investment climate, the high returns achieved in the All Bond Index in 2016 are probably unlikely to be matched this year. Investors in fixed interest should instead consider increasing their exposure to a higher percentage of short-dated fixed income assets such Income Funds which still offers superior risk adjusted returns.
Listed property performance is likely to be influenced by the changes in the bond market yields.
Weakening of bond yields is likely to keep listed property returns subdued. However, the sector has changed over time and has proved partially immune to local events, given that almost 40% of earnings come from outside South Africa through local property with offshore exposure in countries such as Australia, Eastern Europe and the UK.
Over the past few years, the number of offshore property companies with a secondary listing on the JSE has increased, further diversifying the local listed property sector.
Globally, listed property presents a number of investment opportunities in the US, Australia, Japan and select regions in Europe spanning sectors such as shopping centres, student housing, hospitals and prisons. Global property is expected to deliver higher returns based on more opportunities. Locally, there are some risk factors to monitor, given the likelihood of increasing interest rates, which will push borrowing costs higher.
Current high valuations combined with slower economic growth and above-average volatility in the short term may encourage investors to consider lower fee options for a portion of their portfolio.
Passive strategies are increasingly being used to capture market beta at low cost. A weaker rand environment is likely to drive equity market returns, benefiting passive index trackers.
For investors, the most important response is to remain calm and focused on the long term. Although political risk is unsettling and creates anxiety, investment opportunities will emerge, rewarding patient and prudent investors.
From an economic growth perspective, South Africa should continue to benefit from the current uplift in agricultural production, as well as the improvement in exports helped by somewhat higher commodity prices.
South Africa has managed to move from a running a large trade deficit into more regular trade surpluses. As a consequence South Africa’s current account deficit has improved dramatically. It is also worthwhile reflecting on the fact that many emerging market economies experience political turmoil from time-to-time and that foreign investors are relatively well acclimatised to these types of development. This suggests that despite serious concerns about the cabinet reshuffle, foreign investors will continue to find opportunities in South Africa as they do in Brazil, South Korea, Russia and Turkey, all of whom have also recently experienced political turmoil.
Author: Kevin Lings, STANLIB Chief Economist and STANLIB Investment team
Because no one knows what the future holds, a diversified strategy can be more advantageous than shifting too much in any direction. You can resist the temptation and save yourself the stress by tuning out the noise
As the tensions over multiple macroeconomic, geopolitical and fundamental issues grow, the temptation for many investors is to do something. In general, we all prefer to do something at times of stress and uncertainty rather than doing nothing. In behavioural finance, this has been dubbed ‘action bias’.
A great example of this can be seen in football games. Imagine you are the goalkeeper facing a penalty kick. What do you do? Dive right? Dive left? Stand still?
A 2007 study looking at how goalkeepers react in the face of a penalty kick found an ‘action bias’ – they jumped to the left or to the right significantly more than was useful in blocking goals. They jump to the left or to the right an overwhelming 94% of the time – meaning they stay in the middle only 6% of the time. In comparison, the shot went towards the centre 29% of the time.
The key here is that the goalkeeper is motivated by the fear of regret rather than the fear of failure. To have dived and failed feels better than standing still and failing. Diving isn’t reducing the potential for actual loss (the goal is scored) but does reduce the emotional loss to the goalkeeper.
Investors now find themselves in a similar position. Do you trade or do you hold your positions? Would trading now make you feel better? Action bias might lead us to make some radical changes in investment strategy either by shifting funds between investments or by sitting in 100% cash for fear of losing more. Both would be a mistake in our opinion: essentially the risks of short-term attempts to time the market outweigh the expected long-term benefits.
The action bias tends to be asymmetric – we feel a strong desire to jump ship to avoid losses but typically find it very difficult to get back into the market once we’re out, particularly after a drop, when it would be most beneficial.
In investing, if we’re to achieve returns, we need to take risks – fact. If we’re going to take risks, then periods of loss are not a danger, they’re a certainty – fact. But these certain losses are not a problem in the long run … selling when you have a loss is. The action bias tends to lead to frequent short-term, emotional trades, the benefits of which seldom outweigh the risk.
The bias leads us to want to do something but doesn’t lead us to anything specific. So if you feel compelled to do something – as most of us do look for actions that are constructive.
We know that investors tend to make serious behavioural mistakes at this time and this is when they require sound advice and reassurance. We at Investec Wealth and Investment maintain as a core philosophy of wealth management that staying the path of a well-constructed and diversified investment portfolio will ultimately lead to real risk-adjusted returns through market cycles.
Here are a few simple rules to help you through the current feverish reaction.
Rule 1: Recognise that volatility and periodic corrections are common in equity markets
The key to getting through unexpected turbulence is to understand that swings in the financial market are normal – and relatively insignificant over the long haul. The best approach to protect portfolios is to diversify among a broad mix of asset classes so that you are better poised to buffer the declines in the equity market.
Rule 2: Tune out the noise and remove emotion from investing
According to a study done from 1995 to 2014,1 the ‘investor behaviour penalty’ (investors’ propensity to buy and sell their investments at the wrong times) amounted to 3,9% per annum. On a R1 million initial investment, this translated into a difference of R2,95 million growth over a 20-year period (R5,7 million versus R2,8 million).
Seeing the same story at the top of every news site you visit, as well as related portfolio fluctuations, is likely to worry you more than it should.
If you’re a long-term investor, resist the urge to make drastic changes to your investment plans in reaction to market moves. You may find what’s driving the overreaction in markets is nothing more than speculation.
Making shifts to your portfolio in the hopes of avoiding a loss or finding a gain rarely works long term. Investors who panicked and dumped equity holdings in 2008 and 2009 believing they could get back in when ‘the coast was clear’ likely suffered equity losses without the benefit of fully participating in the recovery.
Also, try not to look at your accounts every day. It’s unnecessary and may do more harm than good. Remember that portfolio changes, aside from routine rebalancing, can result in significant capital gains. And don’t forget you need to know when to jump out of the market and then get back in – decisions few investors can and should tackle.
Rule 3: Make volatility work for you
Save more and continue to invest regularly. Boosting savings is important to your long-term financial goals. We believe market returns may well be muted over the next few years; therefore, stick to your investing principles and avoid getting caught up in the market.
If you invest regularly you’re putting the market’s natural volatility to work for you. Continue making contributions to take advantage of rand-cost averaging. Buying a fixed rand amount on a regular schedule offers opportunities to buy low during market dips. Over time, regular contributions can help reduce the average price you pay for your investments.
The inaction plan
If your portfolio is broadly diversified and has the appropriate balance for your financial goals, time horizon, and risk comfort level, sticking with it is a wise move.
It’s okay to ignore volatility – that’s part of the plan. Don’t just do something, stand there!2
Although information has been obtained from sources believed to be reliable, Investec Securities Proprietary Limited (1972/008905/07) or its affiliates and/or subsidiaries (ISL) does not warrant its completeness or accuracy.
2 Many of the insights above draw upon a blog by Greg B Davies PhD from 4 August 2011.
Author: Patrick Duggan is Wealth Manager at Investec Wealth & Investment
Making the most of short-term savings
In the current low-return environment, every rand counts. Whether you are in retirement or investing to build a better future, consistent investment performance and resilience against market fluctuations are critical to achieving your goals
Taking into consideration the current economic backdrop, you can understand why investors still prefer to hold much of their investable assets in a call account or fixed deposit. The primary reason for this is that investors believe that they are keeping their hard-earned rands in the safest place possible.
Unfortunately, investors who take this overly conservative position may be losing ground against inflation. Holding too much cash in a call account or a fixed deposit is currently not a good strategy, even for the most conservative investor.
Given where the South African interest rate cycle is at the time of writing this article, investors are in a position to earn a positive real return if invested in fixed interest assets further up the yield curve.
‘Moving up the yield curve’ explained
‘Moving up the yield curve’ refers to looking beyond a call account or fixed deposit to other fixed interest investments where you can earn a higher return.
- A call account offers slightly higher interest rates compared to a normal bank account.
- A fixed deposit is a low-risk investment but it limits you in terms of access to your money.
- Money market funds offer attractive returns and are low risk while offering better accessibility compared to fixed deposits.
- An income fund carries a slightly higher risk profile compared to a money market fund or call account. However, investors are compensated for this in the form of higher returns.
Time frame matters
Many investors choose to leave their cash in a call account because they want quick access to their money when they need it. However, we have found that investors often leave cash in a call account for much longer than initially anticipated. Instead, they could invest in either a money market or an income fund where they would earn a better return.
Money market versus income funds
Money market funds first and foremost aim to preserve capital by investing in short-term (less than 13 months) securities and liquid debt. By investing in a money market fund, you diversify your risk across a number of banks compared to a call account or fixed deposit which carries the concentration risk of one bank.
Money market funds are generally used as short-term savings vehicles for investors looking to earn a higher return, preserve capital, and liquidity.
An income fund achieves higher yields than a money market fund because, among other factors, it is allowed to invest in slightly longer duration debt, primarily consisting of floating rate instruments.
A number of techniques are used to generate returns, including managing duration, credit exposure, and the curve position of the assets.
Your money is generally available within 24 hours but the nature of income funds suggests staying invested for at least 12 months.
As indicated in the graph, investors are currently able to earn a real return in most money market and income funds. Generally, call accounts and fixed deposits are not able to keep pace with inflation.
Source: STANLIB – effective yields as at 17 March 2017, South African Reserve Bank
How do short-term savings options compare?
Banks calculate the interest rates they offer based on the amount of savings you have. The more your savings, the higher the interest rate they can offer. These are the typical interest rates offered on 32-day noticed accounts:
While interest rates and inflation will inevitably turn, taking into account the current economic environment and expected returns for other asset classes, income funds present what seems like a ‘no-brainer’ for shorter-term investments.
Author: Henk Viljoen is Co-head of STANLIB Fixed Interest Franchise
As young professionals, the world is your oyster. Your earning potential is growing and your savings is becoming a meaningful amount. You can start living life. And you may start to believe that you can retire rich and famous. Why do most professionals get it wrong? Because income is not wealth
The investment world offers literally thousands of products locally and globally. These range from simple share portfolios to unit trusts, tax-free savings accounts and more sophisticated products like hedge funds and ETFs.
Then there are all sorts of ‘wrappers’ in the insurance industry – such as endowments and retirement annuities as well as a variety of asset management approaches to consider: active, passive, tracker, multimanager, quants, etc.
Once you’ve decided on these factors, you also need to decide how you’d like to access these products (online or through a direct investment), or if you’d like to go the route of ‘robo advice’. If you see a financial adviser, the advice may be ‘free’ (if they earn commission) or you may pay fees, which everyone warns you can erode the value of your investments.
Finally, you also need to consider tax and estate planning implications as complying with the various pieces of legislation (FAIS, FICA, CISCA, Long-term Insurance Act, etc).
The intention is not to overwhelm you with the complexity of it all, to dazzle you with the breadth of choice or alternatively to scare you, rendering you confused and immobilised. Rather, it is to emphasise the importance of understanding the basics before you jump right in.
Have a plan
What is it that you are trying to achieve? And then follow that question up with: how, and by when?
The pillars of wealth creation are your income-generating capacity, how long you work, and your ability to spend less than you earn and save. The higher your income the more you can potentially save; the longer you work the more you can save; and savings compound over time.
Your plan needs to look at short-, medium- and long-term horizons as the solutions for each of these will be different. Short-term goals (like an overseas holiday) need cash-type assets that are liquid and less volatile than say a retirement fund, where you have a 40-year investment horizon and should be invested in equities which, while volatile, provide the best long-term returns.
The earnings potential of professionals may be envied by others, but people seldom factor in the lost years of income (and compounding on this) while studying and completing articles.
Thomas Stanley’s book Stop Acting Rich states: ‘Nothing has a greater impact on your wealth and your consumption than your choices of house and neighbourhood. If you live in a high-priced home in an exclusive community, you will spend more than you should and your ability to save and build wealth will be compromised.
‘People who live in million-dollar homes are not millionaires. They may be high-income producers but, by trying to emulate glittering rich millionaires, they are living a treadmill existence.’
Income is not wealth. Wealth is what you accumulate, not what you earn. Plan to pay yourself first each month.
Understand your assets
Cars, mountain bikes, holiday homes, big-screen TVs and the like are lifestyle assets. This is not retirement wealth, no matter how hard we persuade ourselves as much.
When you start out, your biggest asset is you. Based on the research, young professionals can generate earnings in excess of R60 million over their career. So, income is not the problem. However, if you become mentally or physically disabled, temporarily or permanently, and cannot work (it does happen), your earning potential can be compromised. And as you start acquiring a home, committing to a family, funding your children’s education, etc, you can find yourself in a situation where ‘life happens’.
Life, disability and income protection insurances should not be discretionary items. In fact, if you want to build wealth and protect it going into the future, they are essential. While you insure your car and home quite happily, don’t forget to insure your biggest asset: you.
And as your investments grow, and liabilities decrease, review your plan every year so as to change the mix of insurance and investments to meet your changing needs and lifestyle.
Beware of your behaviours
The old saying that ‘markets will succeed, while investors generally fail’ is backed by mountains of research. Dalbar’s 22nd Annual Quantitative Analysis of Investor Behaviour noted that:
- In 2015, the average equity mutual fund investor underperformed the S&P 500 by a margin of 3,66%. While the broader market made incremental gains of 1,38%, the average equity investor suffered a more-than-incremental loss of -2,28%.
- In 2015, the average fixed income mutual fund investor underperformed the Barclays Aggregate Bond Index by a margin of 3,66%.
- In 2015, the 20-year annualised S&P return was 8,19% while the 20-year annualised return for the average equity mutual fund investor was only 4,67%, a gap of 3,52%.
The reality is that we just can’t help ourselves. We love the ‘too good to be true’ solutions and we compete against our friends for the next hot tip. We still have the behavioural instincts of our cavemen ancestors when it comes to following the herd. We sell low and buy high. We become paralysed when faced with too much choice.
Inflation and compounding
Inflation is your biggest enemy. A 5% inflation rate will erode some 85% of your purchasing power over 40 years. In 1965, the Ford Mustang Fastback Coupé sold for R3 488. In 1979, a Mercedes-Benz 230 sold for R12 103. In 1989, the Toyota Corolla 1,6 GLI Twin Cam was R45 495. In December 2000, an Audi TT Roadster 1,8t Quattro was the extravagant sum of R314 000.
If you want your wealth to have any value in the future, your investments need to generate returns in excess of inflation. One of the biggest risks is ‘reckless conservatism’ – we are so scared of volatility in the markets that we ‘keep the money under our mattress’. It may be safe in the short term but will be catastrophic in the long term.
The best friend you will have when you start investing is the time that is on your side and the power of compounding. Albert Einstein called compound interest the greatest mathematical discovery of all time. It’s about allowing your money time to work for you, reinvesting the earnings and avoiding lump sum withdrawals. Just R5 000 a year (R400-odd per month), at 8% for 45 years, would grow to over R2 million. Try saving R2 million in your last five years before retirement and you would need to be saving some R30 000 per month.
‘The amount of capital you start with is not nearly as important as getting started early,’ says Burton Malkiel in The Random Walk Guide to Investing. ‘Procrastination is the natural assassin of opportunity. Every year you put off investing makes your ultimate retirement goals more difficult to achieve.’
Advice and fees
So, do you need advice and should you pay fees? The answer depends on where you are in your lifecycle and your needs. If you are starting a simple savings plan, cost-effective solutions are available online, with enough information to understand the products and advice tools to assist you in selecting an appropriate investment.
As your needs and objectives change with career growth and family life, advice becomes more critical. The plan becomes more demanding. It becomes more about risk protection, estate planning and tax planning, as well as finding the right investment for competing objectives. Seek professional advice to help build and revise your plan, find the right products, and manage your investment behaviours.
As with any professional, advisers expect to be paid, and international research (Advisor ‘Gamma’) shows that this can add 1,6% per annum to your returns. Fees always need to be transparent and can be negotiable. Value for money is the key measure.
There are also a multitude of other fees for the asset managers, investment products, life wrappers, management companies and administration platforms. Again, the debates rage and there is no doubt that these costs, compounded over many years, can erode the value of your wealth quite significantly. So, understand the fees but also the value you’re getting in return. Cheap is not always best and Dr Google can only do so much.
Does this work?
As the second richest man in the world, Warren Buffett, advises: ‘To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.’
Focus on your financial health, get the right diagnosis and don’t just reach for the medication. Investing is boring, requires patience and long-term thinking.
Author: Mike Lledo (CA) SA is an Associate of Citadel Investment Services
Crowdfunding has made a mark in the financial services industry within many jurisdictions and as much as there may be a need for regulation, sight must not be lost for what appears to be the main objective of crowdfunding, which is to facilitate easy access to capital and alternative means of financing
Crowdfunding is a way of soliciting funds from the public on an online platform; money is raised in small amounts usually in the form of donations or investments. It is essentially a vehicle to source funds from individuals or organisations to fund different causes ranging from business ideas to charity initiatives. For businesses, crowdfunding promises capital for inventive entrepreneurs in need of funding while for charity causes it promises a helping hand. The crowdfunding model has the potential to impact on the growth and development of small businesses and in most jurisdictions including South Africa, crowdfunding is seen as an innovative way to facilitate funding for small and medium-sized enterprises and finance start-up companies, with a goal of promoting economic growth.
Crowdfunding is not a new concept; however, in South Africa the crowdfunding model of financing is still in its infancy stage, it is a concept which is not clearly understood or trusted by most, and a financing model which has proved to be difficult for the Regulator (the Financial Services Board) to regulate forthrightly. As it stands, the activity of crowdfunding is not regulated in South Africa, there is no specific mention of ‘crowdfunding’ in any piece of legislation, and there is no proposal of legislation in the pipeline.
Crowdfunding has been argued to raise potential risks to the investing public within the financial services industry such as fraud, money laundering, platform failure and business failure as funding does not guarantee returns, lack of due diligence and disclosure risks such as lack of liquidity and the inability to obtain a return on the investment. It is because of such potential risks that a need for regulation arises in order to protect the unsuspecting crowd but also further promote the certainty within the general public.
The Financial Services Board has noted the activity of crowdfunding in South Africa and has highlighted that despite the absence of regulation, crowdfunding activities may already be subject to or find application within existing legislation, to that end it has advised that a person interested in crowdfunding activity either by offering it or as an investor must first contact the Financial Services Board to establish whether the activity falls within the sphere of existing legislation or otherwise falls foul of the law. The following are examples of legislation which may be applicable to crowdfunding activities (depending on the structure of the online platform):
- Companies Act 71 of 2008
- The Banks Act 94 of 1990
- National Credit Act 34 of 2005
- Financial Advisory and Intermediary Services Act
- Financial Markets Act 19 of 2012, and
- Collective Investment Schemes Control Act
In light of the highlighted risks and the approach adopted by the Financial Services Board, the question that arises is whether it is credible to assimilate the model of crowdfunding with activities that are generally regulated under existing legislation while keeping in mind that crowdfunding may be associated with a number of elements such as investment management, consumer protection, client credibility, tax implications and intellectual property or is the way to go for the Financial Services Board to propose a specific piece of legislation designed to cater for all the identified needs, risks and uncertainties.
This may therefore be an opportune time for the Financial Services Board to engage with the industry on a way forward, because not only is crowdfunding a great alternative to financing businesses, it has made a mark in different markets within the financial services industry. Without losing sight of the benefits of crowdfunding – particularly in respect of the economic policy of South Africa, which is to promote economic growth, job creation and innovation through encouraging the development of small businesses – there is a need for regulation to protect the ‘crowd’ that will be investing in these businesses or projects. Therefore the Financial Services Board’s challenge will lie in striking a balance between encouraging crowdfunding, which promotes easy access to capital for businesses, and protecting investors.
The adoption of the Twin Peak model of regulation in South Africa will see the creation of two regulatory authorities, the Prudential Authority and the Financial Conduct Authority. Seeing that risks associated with crowdfunding predominantly relate to conduct, it is likely that crowdfunding regulation may fall within the perimeters of the Financial Sector Conduct Authority, whose objective will be to protect financial consumers through supervising market conduct.
Authors: Portia Mashinini is a candidate attorney and Lerato Lamola a Senior Associate, both at Webber Wentzel