Interest rate risk. Low. Moderate. Longevity risk. High. Very low. Inflation risk. High. Very low ... that money market
A WORD FROM OUR CIO Don’t sacrifice long-term returns for short-term peace of mind
Adriaan Pask CIO PSG Wealth
Market volatility and rising interest rates generally spook impatient investors. These conditions have now created an environment where many investors allocate too great a weighting to their cash holdings. Although the PSG Wealth investment division believes that cash plays a strategic role in a diversified portfolio of different asset classes, it is not ideal to invest in cash in isolation. You should be aware of the longer-term trade-offs of allocating a significant portion of your long-term investment capital to cash.
Market risk is not the only risk to consider Successfully growing your long-term wealth depends to a large degree on not making emotional, knee-jerk decisions in reaction to volatile market movements. Market risks or volatility (which most investors are generally more aware of) usually result in a migration away from riskier assets such as equities to perceived safe-haven investments such as term deposits or money market accounts. However, during such times, investors caught up in the panic are notably less aware of other risks that could affect longer-term returns, such as inflation risk and longevity risk. Inflation risk is the risk that long-term inflation growth will exceed the long-term investment growth of your portfolio, thereby effectively reducing the purchasing power of your savings. Longevity risk is the risk of outliving your savings, if your long-term investment growth is insufficient to sustain your future living expenses. Due to medical advances, global average life expectancy now far exceeds 85 years – the age to which investors generally plan their investment horizons. Recent research shows that by 2030, average life expectancy will
exceed 100 years – this is already the case in seven countries. In fact, average life expectancy increases by five hours every day1. To successfully grow wealth over the longer term, you need consistent exposure to equities to hedge against both inflation and longevity risk.
Inherent risks in cash and equity investments Risks
Cash
Equity
Equity market risk
None
High
Exchange rate risk
None
Low
Interest rate risk
Low
Moderate
Longevity risk
High
Very low
Inflation risk
High
Very low
Source: PSG Wealth investment division
South African lifespans can be longer than expected Probability of reaching stated ages
65-year-old man
65-year-old woman
65-year-old couple*
50% chance
85 years
89 years
94 years
30% chance
91 years
95 years
99 years
25% chance
93 years
97 years
100 years
20% chance
95 years
99 years
102 years
10% chance
100 years
104 years
106 years
* At least one surviving Source: Sanlam
SECOND QUARTER 2016
A WORD FROM OUR CIO
Don’t bet against equities The good news is that most of us will probably live longer than what we expect. This means that most of us will have more time to give our investments the required time to grow. Equities can help you to do this successfully over the longer term. While stock prices might suffer during periods of market volatility, research conducted by our investment division shows that money market accounts usually underperform the FTSE/JSE All Share (ALSI) Index over rolling 10-year periods. The graph below shows that in the 10 years preceding the peak of the financial crisis (31 March 2008), the ALSI returned
19.4%, compared to 11.2% from the money market. More recently, in the 10 years preceding 31 May 2016, the ALSI returned 13.34% and the money market 7.5%. Unfortunately, there is a perception that equity is the riskiest investment. However, this depends on your investment horizon – and the type of risk you consider. While cash will grow at a steady pace, investing in equities managed by active managers can reduce longevity risk. You may therefore well be rewarded with an ‘equity premium’ over cash returns in exchange for the shorter-term certainty you sacrifice. If you remain cognisant of the bigger picture, you will find comfort in the long-term probabilities that are stacked in your favour.
Returns delivered by the ALSI versus the money market over rolling 10-year periods 25.0
20.0
15.0
10.0
5.0
0.0 JUN ‘05
JUN ‘06
JUN ‘07
JUN ‘08
JUN ‘09
JUN ‘10
FTSE/JSE All Share TR ZAR
JUN ‘11
JUN ‘12
JUN ‘13
JUN ‘14
JUN ‘15
JUN ‘16
Alexander Forbes Money Market ZAR
Source: PSG Wealth investment division
Risks inherent in individual cash instruments Investing in cash instruments might seem more attractive during uncertain times, but comes with its own inherent risks. A cash instrument might be exposed to credit risk, especially if the bank issuing the instrument is not scrutinised by rating agencies. The instrument-specific risk is also very high, because the investment is in a single security as opposed to a pool of diversified assets.
The table on the following page sets out other risks associated with cash instruments, compared to a diversified cash fund – in this example, the PSG Wealth Enhanced Interest Fund. If you have a short investment horizon or your circumstances require you to prioritise the preservation of your wealth above further investment growth, such a fund may be a more suitable alternative to cash.
SECOND QUARTER 2016
A WORD FROM OUR CIO
Risk exposure of bank deposits versus diversified cash funds Bank deposit
PSG Wealth Enhanced Interest Fund
Credit risk
Specific to the bank issuing the instrument, which may or may not be rated by agencies, and may or may not be investment grade credit
Mandated to only invest in investment grade credit
Security-specific risk
Large – only one security
Minimal, as assets are pooled within a diversified portfolio
Sector-specific risk
Exposed to the banking sector in isolation
Banking credit is blended with credit from other sectors to spread sector-specific risk
Liquidity
Usually restricts liquidity to a specific term or notice period
Readily available
Regulation
Not explicitly approved by the FSB
Explicitly FSB-approved
Governance
The Board has to manage the bank’s balance sheet risk within its operating environment
Assets monitored by independent trustees on a daily basis
Active management
None – one asset held to maturity
Portfolio managers actively manage assets to improve returns
Source: PSG Wealth investment division
Follow sound investment principles It is easy to get fixated on investment factors that are beyond your control, such as market volatility. We believe that paying careful attention to sound investment principles is of far greater value. There will always be some level of volatility in the markets. The secret to successfully navigating this volatility remains to start investing as soon as possible and to be patient. No one can predict with certainty when a market will turn, but professional money managers have the knowledge and skill to approach different market cycles sensibly.
For the PSG Wealth investment division, three key wealth management principles have increased in importance this year: diversification, managing investor expectations and investing in appropriate products (considering both time horizons and risk). Although these principles have always been the cornerstones of our wealth management success, tough times demand placing even greater emphasis on them. 1
Sanlam research, 2016
SECOND QUARTER 2016