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Investments: So how much interest do you offer?

Investments: So how much interest do you offer?

By Cassie Carstens

Although this question is not phrased in a sensible way, it is one that is often asked. This is due to the turbulent nature of everyday news flowing from markets and the desire for a consistent pattern of return. A more appropriate question to ask is with how many percentage points will a client allow you to pursue a mandate to beat inflation over time? The statement is seldomly structured in this way, although this is understandable.The return generated from a fixed rate investment, for example a fixed deposit at the bank, is pure interest. The return generated from a typical multi-asset allocation unit trust will consist of capital growth, interest and dividends, either from a local or foreign source. This composition obviously does not allow for a consistent or predictable return pattern.

In a normal investment cycle there will often be times where you will perform substantially better in a money market or fixed deposit account at your local bank. On the other hand, there will also be times when your investment is outperformed by cash or even decreases in the short-term. Advisors are prompted to refer to long-term growth in such cases, but your average client will find it difficult to digest if his or her short-term figures do not reflect it. We see how people’s horizons, especially in turbulent times, become shorter and performance is judged on a quarter-to-quarter basis and sometimes even monthly.

It is important to compare your investment to a realistic benchmark and understand whether your investment has under- or overperformed in relative terms. Take the following example, if you assume that the JSE ALSI drops by 20% and your equity unit trust fund drops by 10%, you have outperformed your benchmark. You are however beaten by inflation and there is no real performance. In times like these it is not fair to compare a fixed-interest money market investment with an equity unit trust.

This situation has evolved recently where local stocks moved sideways for almost two years, (May 2015 to June 2017) and the rand substantially strengthened after the 2015 Nene-gate fiasco. Investors have become wary of pure equity funds, but the irony is that even balanced funds were outperformed by money market funds in these times. “How much interest do you offer?” had become an increasingly difficult question to answer, given that the two-year period had a substantial impact on any growth figures you could present.

The experience that an investor has during his investment cycle relies heavily on his starting point or how much of a buffer was built up in the initial phase of the investment or not. Let me explain by using two investors as example: one that has already been invested for some time (from 2010) in a combination of well-known Balanced Funds (Allan Gray, Coronation, Prudential and Investec) and one that only started investing in 2016 in the same combination of funds. I then compared what the investors’ experiences would have been compared to a well-known money market investment.

Please refer to the outcome below:

 

Source: Allan Gray Online Fund Research

Investor 1 received decent returns over the first number of years and had built up a buffer from the growth for the underperforming years that followed. The compound growth since inception was a very satisfactory 11.8% per annum against the Money Market investment of 6.48%.

Source: Allan Gray Online Fund Research

Investor 2 did not have the advantage of the prosperous years and his 2-year compound growth was only 6.99% per annum, almost a percentage per annum less than he or she could have earned from a money market investment.

Therefore, if you started investing in a pad patch of the investment cycle, you could experience some discomfort with regards to your returns for an extensive period, leaving you anxious about whether you should have left your money in your money market account. What is important to know is that you will end up at the same destination if you stay on track, whether your investment’s uphill appears at the end or at the beginning.

In the table below, you will see Investor 3’s experience with 2016/2017 as the starting point of his or her long-term investment timeline. The investor is initially beaten by the money market fund, but quickly outperforms the money market fund and finishes well ahead.

 

Source: Allan Gray Online Fund Research

To conclude, you can’t choose the investment journey you are going to experience, but you can choose how you respond to it. A great part of your investment’s eventual absolute outperformance is how you can process irrational market fluctuations and remain focused on your investment objective. Your sourdough bread, single-origin coffee and those Woolworths chips will only become more expensive and the potential intent of any investment should always be to beat the inflation beast. Always question your investment’s relative performance against a fair benchmark, but remember to maintain perspective regarding your unique return figures given the time of the cycle which you invested in.

Cassie Carstens
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