Offering a prudent balance between reward and risk, ‘real return funds’ take the middle road.
Real return funds are often overlooked in investment portfolios for being ‘too boring’ or ‘too slow to deliver spectacular returns’. Nonetheless they may be highly suitable for investors with a medium- to long-term investment horizon.
The temptation is always there to find a ‘get rich quick’ investment to achieve objectives quicker. We plan for a home of our own, university education for our children, overseas travel, and a myriad of other cash outlays. We would all like a retirement which allows us to enjoy our current lifestyle and possibly afford a second career or philanthropic activities.
Real return funds have a place in achieving such dreams. They seek to participate in positive market movements without taking on too much risk, to outperform the market during downturns and to ensure capital preservation. Their primary objective is outperforming inflation over the long term while ensuring capital preservation.
However, investors must be willing to endure periods of market underperformance as long as capital is preserved. Furthermore, it is also important to note that despite prioritising capital preservation, these funds offer no guarantees.
By employing a balance between fairly aggressive, equity heavy asset allocation (to target inflation-beating returns) and careful risk management (to ensure capital preservation), these funds are by their nature actively managed. In contrast to passive, index-tracking funds – which aim to match the market or duplicate a market index, and will rise and fall as the market does – real return funds target constant positive returns above inflation, regardless of market performance.
In contrast, a single asset class such as a resources or property fund may provide highly attractive returns over a period – but at what cost in volatility and risk?
In most cases, real return funds have maximum exposures of 40-75% to equities depending on the ASISA rules and up to 25% exposure to offshore assets. A flexible mandate will ensure the fund manager can target a positive absolute return throughout the economic cycle.
According to PPS Investments, as a result of extremely low global interest rates, real return funds have for several years been close to their maximum allowed exposures to equity and offshore assets. With interest-bearing assets unlikely to deliver inflation-beating returns, managers have been forced to search for yield.
In addition, property as an asset class has arguably been overvalued in South Africa, while there was still value to be found in offshore property. However, of late managers have started to shed some risk and are positioning their portfolios more defensively.
While real return funds may not necessarily be the most exciting investment, we believe they have a core role in helping investors achieve their financial planning goals. ❐
Author: Mike Lledo CA(SA) is the CEO at Consolidated Financial Planning.