By Andre Basson – Brenthurst Wealth
Time to invest in diversified and resilient portfolios, control what you can and avoid what you cannot.
There is a lot of uncertainty in today’s investment markets: US Fed stimulus drying up, higher inflation and interest rates, economic impact and changes due to Covid – to name a few. To get sustainable long-term growth from investments investors need to understand the nature and role of each investment made and their role as an investor:
1. Understand your goal and horizon
Do you need capital protection and/or capital growth? Do you need to draw an income? Do you need to use some of your funds in the near future? The construction of your portfolio, and the asset classes selected, should be determined by these questions. Your investment horizon will be the biggest factor – any part of your portfolio that can stay invested for five to seven years can be invested into aggressive funds. If you have a shorter horizon for a certain portion of your portfolio, then this should be invested in conservative (one to two years) or moderate/balanced strategies (three to five years).
2. Understanding asset classes
The four main asset classes are cash, bonds, property and equity – all of which can be found on local and offshore markets. Cash and bonds are seen as more conservative asset classes and can be used to give an element of preservation/protection from equity market corrections. You can expect lower growth but higher income (typically higher than the money market). Property and equity can be seen as aggressive asset classes used to generate long-term growth. Income is derived from dividends and is mostly lower than from income funds (cash and bonds), but growth is higher over the long term. Not all equities are the same and will provide different growth; it is important to understand which sectors and companies (equity) you own.
3. Understanding local vs offshore
Offshore markets offer a wider opportunity set for investors, which can increase diversification and growth. It does increase volatility as the rand/US dollar exchange rate fluctuates daily and contributes to the overall fluctuation of your portfolio. Offshore equity is mostly more expensive than local, but a combination of the two makes sense for most investors. The percentage to allocate to each will be determined by individual needs and risk profile. Local cash and bonds offer superior yields when compared with offshore counterparts.
4. Understand investment styles
Growth, quality and value are the three most common investment styles used by fund managers or thematic exchange-traded funds (ETFs). Each has its own characteristics, strengths, and weaknesses – understanding these remains most important.
- Growth style – uses companies that innovate and grow very fast, typically by using new technology and growing market share quickly. These stocks mostly trade at higher valuations. Examples here include Amazon and most technology stocks. Pro: you get exposure to the most innovative companies that continue to drive innovation and adapt to change. Con: trading at high valuations, can be a ‘bumpy ride’ for investors.
- Quality style – uses companies that have dependable income streams, strong balance sheets and sell ‘sticky’ products and services. They can sustain profits during good and tough times and generate returns for investors by compounding their earnings over time. Examples here include Visa, Estēe Lauder and Nestlé. Pro: steady growth over the long term. Con: underperform in bull markets
- Value style – uses companies that trade on low valuations and are undervalued by the market. Typically found in cyclical industries such as banking and mining. Pro: low valuations offer a good entry point; if the global economy recovers and inflation persists these stocks tend to do well. Con: some industries/stocks are invested in challenged areas that do not provide much innovation/growth over the longer term.
Different styles perform well in different economic cycles. It is impossible to time the markets, therefore a combination of styles makes sense. Understanding the strength of each style and the needs of each investor can help them make specific choices and determine if you are overweight (invested too much) in a certain style.
5. Understanding fund managers
The options of different unit trusts and fund managers are vast and can be overwhelming. It is the job of a good financial advisor to understand these differences and build long-term relationships with good fund managers who perform well over the long term. Not all fund managers are the same, even within the same ‘investment style’. There is a lot of small nuances and differences. Understanding these – which an experienced, qualified advisor can assist with – will help you invest with a specific goal in mind.
6. Understand your role as the end investor
Market valuations are driven by human decisions to sell and buy stocks and are often made based on fear or greed. Therefore, markets will always be volatile in the short term and your growth won’t arrive in a straight line. By embracing market volatility and staying invested, you eliminate the risk of market timing and create a more resilient long-term return profile for yourself. But when you understand what you invest in and the reasons for it, you are more equipped to stay invested when the going gets tough.
A last note: with the US Fed reducing stimulus, expectations for interest rate hikes and the unknowns of Covid, we do expect a tougher investment environment. Now as ever it’s time to invest in diversified and resilient portfolios, control what you can and avoid what you cannot.