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October 22, 2019

Yes, you can achieve above inflation returns and be cautious

By: Radhesen Naidoo and Stephan Bernard of Allan Gray.Risk averse investors, including those approaching or in retirement, tend to shy away from equities due to their volatile performance. Instead they opt for the relative safety of cash. But this has implications for the long-term sustainability of their investments.Bank savings accounts currently offer returns ranging from less than 1% to a potential 9% if you’re willing to lock in your money for an agreed period, like in a fixed- term deposit. The median return is barely keeping pace with the current inflation rate, which was 4.5% in March 2019, up from 4.1% in February. Consequently, the purchasing power of your capital, when saving in a bank account, will most likely be eroded by inflation over time.“Equities have shown the ability to outperform inflation over the long term. However, with the potential for greater returns comes the increased risk of capital loss, as well as increased short-term volatility,” according to Radhesen Naidoo and Stephan Bernard of Allan Gray.Naidoo says that generally an equity fund, or balanced fund that includes equities, would be able to meet the needs of an investor saving with long-term goals in mind, and able to stomach volatility. But what if you need real returns but you can’t tolerate as much volatility, is there a way to beat inflation?“Pure cash investments are unlikely to go the distance. To generate investment returns that beat inflation over time, the reality is that investors have to include other asset classes, like equities, in their portfolios. The key is to strike the right balance for your personal circumstances.”


For the more risk-averse investor, one option to consider is a ‘defensive’ or ‘stable’ unit trust from the Multi Asset – Low Equity unit trust category of the Association for Savings and Investment South Africa (ASISA). As the category name suggests, these unit trusts can invest in the full range of assets, like equities, bonds, property, money market instruments and offshore investments. However, they are restricted to a maximum equity exposure of 40%, and 25% for property. As a result, they usually display lower short-term volatility and aim to provide long-term capital growth. Therefore, the unit trusts in this category are generally a good option for investors seeking inflation-beating returns with fewer ups and downs than multi- asset unit trusts with higher equity weightings.Within the parameters of this category, the asset mix for any particular unit trust will depend both on the unit trust’s specific mandate and on the investment managers’ opinions on where they’re finding value at the time. For example, if they’re cautious about the equity market, they may increase the unit trust’s allocation to bonds or money market instruments instead.The benefit of multi-asset unit trusts is that you don’t have to think about all the decisions yourself – the investment professionals take care of the unit trust’s asset allocation and select the specific underlying investments, all you need to do is pick a unit trust from the category most suited to your needs and timeframes.According to Bernard, the Allan Gray Stable Fund is one example of a lower equity unit trust available in ASISA’s Multi Asset – Low Equity category. It is suitable for investors who are risk-averse and require a high degree of capital stability, but at the same time seek above- inflation returns over the long term. The Fund’s local equity exposure has varied over time, going as low as 12.4% in January 2010. However, compared to its average of 25%, the Fund currently holds a relatively high 34.2% (as at 31 May 2019). Bernard explains the rationale for this:“When considering the Stable Fund’s asset allocation our portfolio managers hand-pick the assets, examining them for their return potential and potential drawdown. The Fund is built from the bottom up which means, every asset is compared to cash and the risk/ reward profile is examined. The key question asked is how much is the asset likely to return compared to cash over our investment horizon,” he explains.


“As the prices of our favoured shares move further below what we believe is their true value, the risk of permanent capital loss decreases and the benefit of being invested in these shares subsequently increases. Therefore, we may increase the Fund’s exposure to equities when we are able to identify more cheap shares through our bottom-up investment process, and vice versa. This enables us to put clients’ savings to work at the most opportune times and cut back on risk when shares are expensive, and the risk of loss is higher.”The Stable Fund also invests a portion of its assets offshore, which adds the benefit of diversification and protects investors against potential rand weakness.Says Naidoo: “We recognise that a higher exposure to equities and foreign assets may increase short- term volatility. If we measure risk in terms of short-term return volatility, risk may appear higher than in the past. However, measuring risk in terms of protecting your investment against long-term loss of purchasing power, it is quite the opposite, in our view. Achieving the objectives of the Stable Fund requires us to be mindful of both these risks, as we have done historically, and will continue to do.“It is wise for investors to gauge their investment progress against a yardstick and, although there is no ‘one size fits all’, a common goal for all investors should be to preserve their capital by beating inflation,” concludes Naidoo.While the general consensus among investment experts is that you cannot beat inflation without exposure to growth assets, like equities, it appears there is a middle ground for investors who aren’t comfortable with too much short- term volatility.Of course, it is advisable to talk to an independent financial adviser who can help you pick investments that are best suited to your objective and circumstances.

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