Lessons from 2020 to remember in 2021

Who would have thought we would kick off 2021 in almost the same manner as 2020? Even though we were all hopeful that 2021 would start on better footing, numerous countries are still in lockdown, South Africa is fighting against its second surge of Covid-19 infections and economies worldwide continue to struggle. For humanity, we gladly waved goodbye to 2020, but for markets, we have seen a period of surprising benefit and near-record highs.

Global and local equities, bonds, gold, commodities, and even bitcoin have all moved forward and delivered positive performance despite struggling economies, widespread job losses and the biggest contraction in almost 90 years.

 

The final quarter of 2020 was strong by historical standards. Investor sentiment had been lifted by the news of the rollout of a vaccine worldwide alongside the perception of greater political stability.

 

In an article I wrote at the end of 2020, I used the analogy of a rollercoaster ride to describe the year – not only from a market perspective but especially from an emotional perspective. 2020 marked one of the most severe sell-offs in market history with three of the worst trading days recorded (historically) in March alone. With that being said, we also experienced the shortest bear market recorded (spanning over just 33 days) with most markets now sitting at all-time highs.

 

The one thing that 2020 highlighted again was our behavioural biases, exposing our good and bad traits when it comes to investing.

 

Let’s look at some of the lessons learnt in 2020 that will be worth remembering in 2021 and beyond.

 

1. Markets cannot be timed

Let’s say, hypothetically, you had anticipated that there was going to be a global pandemic, which you know would scare investors across the globe, resulting in sharp declines in the global stock markets, and you decided to withdraw your investment(s). Even with this knowledge, it would have been extremely difficult to predict the timing and strength of the rebound in the market. In this case, the severe downturn has (in many instances) corrected itself within a mere six months. Ultimately, you may very well still be sitting on the sidelines waiting for a better entry point to get back in.

It is critically important to remain invested, through good and bad times. Often the worst days in the market are followed by the best days. Unfortunately, you need to be invested through both the good and the bad to reap the benefits of gaining long-term market returns, which translate into wealth creation over time.

The graph below illustrates how missing a couple of good days in the market can severely impact your portfolio return over time.

2. Good follows bad, and vice versa

Although we have no way of knowing when a market crisis will start, we can be sure that it will end. Historically, a sharp market decline is generally followed by a strong rally. The timing of when that advance occurs is the only unknown variable at play.

South African equities experienced four of the largest one-day losses over a couple of weeks in March. In the below graph –

– The blue bars, show the 10 worst days on the JSE since the end of June 1995 and how the local market reacted after the drawdown.

– The red bars show the 12-month returns investors experienced after the worst day.

– The grey bars show the five-year annualised returns after the drawdown.

 

As an example, during the 2008 global financial crisis on 06/10/2008, there was a loss of -7.12% for the day but the subsequent one-year return amounted to 22.41%, with an annualised (average return per year) five-year return of 19.24% per year.

Yet another reason to remain invested throughout a crisis.

 

3. Optimism remains the only realism.

Humans have overcome incredible challenges throughout the centuries, and we are on our way to overcoming the latest challenge. Little did we realise just how much we would discover, explore, learn, and experience in a year that has brought with it so many different challenges and, in some cases, opportunities.

Let us not forget the lessons we learnt in 2020 as we face the new year that will bring with it, its own challenges and uncertainties.

 

Looking to the future

It is incredibly important that investors must consider the risks they can’t see or at least those they haven’t given weight to. Above all else, investors need to carefully consider the valuations they are paying, as we have seen extreme divergences that presents both an opportunity and a risk.

As Warren Buffett once said, “Only when the tide goes out do you discover who has been swimming naked”. We remain confident that our positions are in the best interests of our clients—acknowledging tomorrow’s challenges and working towards a prosperous 2021 with good financial decision making.

Debra Slabber, CFA®

Portfolio Specialist

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Has 2020 shifted your financial goals?

If this year has taught us anything, it is that we need to hope for the best, but plan for the worst. In financial planning, clients are advised to reassess their financial goals when faced with important life events and/or changes, such as getting married, having a child or with the loss of a loved one. This year, a significant event happened with the outbreak of COVID-19, impacting investors globally. As we approach the end of 2020 and the start of a new year, why not take the time to assess your current financial goals, whether these goals are still relevant, set new goals if needed and make sure you are set-up for success going into 2021.

 

As clients continue to deal with the stressors and worries caused by the pandemic, they may be having trouble making sound financial decisions. Research has shown that we all suffer from behavioural biases, and we can be even more prone to behavioural mistakes during times of uncertainty.

 

Uncovering your real goals

It is likely that 2020 has impacted investors livelihoods and financial circumstances, and thereby also their financial goals.

What are your top financial goals? As investors, we all face this question at some point, and we generally have an answer. But have you ever looked at how stable or consistent your answers are, when you think about them in different contexts or at different times? It may surprise you, but researchers have found that we tend to answer with whatever is top of mind, which may not always be our true, long-term goals.

For example, let’s say a friend recently read an article about vacation trips in Italy. When you ask about long-term goals, the response might be: “I’d like to travel more,” even though the person also cares deeply about leaving a legacy of charitable works. It’s not that the person is insincere or that other goals aren’t deeply held – it’s just that is what’s top of mind and easy to recall.

Tailoring your financial plan around your personal goals can both increase your total returns and motivate you to stay on track1. The success of this technique however depends entirely on having the right goals in place – which research suggests we, as investors, struggle to identify.

To prompt more-thoughtful goal identification, past research suggests that a carefully curated list —a master list — of common objectives can be effective. Master lists have been shown to improve preference identification across a variety of areas. Our research tested the effectiveness of lists for identifying financial goals. We wanted the answer to the question: How can we help investors identify their true financial goals, and not only those that are top of mind?

We found that many people seemed to prioritise goals that were more personalised, detailed, and emotionally grounded after viewing the master list, and the use of a master list also seemed to nudge investors toward more-specific goals.

We found that about half of the people who changed their top goal focused on emotions instead of the outcome. Using a master list drew an important parallel between emotional returns and financial returns. Many people who changed their goals settled on outcomes that revolved around emotional security, such as “to feel secure about my finances now” and “to not be a financial burden to my family as I grow older”. While emotions are often seen as anathema to sound financial decisions, our results suggest that there’s a big emotional component to holistically defining financial goals.

If your goals changed, you’re not alone. At Morningstar, we created a worksheet to guide clients through the process of setting financial goals. Advisors can use this printable exercise to nudge clients toward deeper consideration of what goals are most important to them. This can prompt a meaningful discussion around goal setting and help people avoid top-of-mind, but superficial, goals. We also recommend that you read our research report Mining for goals to find out more about the research behind the worksheet.

Behavioural biases, that often creep in during the goal-setting process, surface when we are facing uncertainty — and when it comes to investment decisions, these biases can hurt more than they help. Investors may benefit from having a resource of their own from which to learn the impact of behavioural mistakes on their finances and how to avoid them. We created a checklist you can send to your clients to help them start to incorporate behavioural techniques into their financial decisions.

This checklist is written for investors, so you can offer clients a resource they can peruse on their own time as well as in your virtual check-ins. This way, you can both work together to help clients thoughtfully navigate their financial decisions and empower them to use behavioural techniques on their own when they may need them the most.

Investors are facing quite a few obstacles when it comes to making thoughtful financial decisions. We can’t erase the emotions and biases that come with these unprecedented times, but effective planning and practicing some behavioural techniques can help investors prevent these factors from getting in the way of their long-term financial goals.

This is where advisors can turn to lessons from behavioural science to help keep investors on track. We’ve created a guide and checklist for advisors to explore how to use these behavioural techniques in their practice.

Understanding your financial goals is central to financial planning but identifying goals that truly matter can be tough. Now, more than ever, we must take the time to avoid behavioural biases, establish strong financial goals, and implement behaviours to help meet these goals.

1 – Blanchett 2015; Locke et al. 1990).

Victoria Reuvers

Managing Director

Morningstar Investment Management South Africa

Risk Warnings
This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.
This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.
Morningstar Investment Management South Africa Disclosure
The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.
+ t: (0)21 201 4645 + e: MIMSouthAfrica@morningstar.com + 5th Floor, 20 Vineyard Road, Claremont, 7708.

South Africa, approaching an income desert?

Income is a dominant driver of most asset class returns over the long run. John Stopford and Jason Borbora, co-portfolio managers of the Ninety One Global Multi-Asset Income Fund, recently wrote a thought piece1 in which they said; “given the importance of income, the decline in yields on most asset classes since the Global Financial Crisis (GFC), and the further fall during the COVID-19 crisis, appears to bode ill for conservative investors … The good news, however, is that there are still attractive opportunities across a range of asset markets and securities.” They conclude, that the key to thriving in this income desert is to build a diversified portfolio by selecting attractively priced individual bonds and equities offering decent yields, but whose income payments are comfortably covered by sustainable cash flows.

1 – Thriving in an income desert, July 2020.

Income also dominates as a driver of total returns when deconstructing the make-up of South African equity, property and bond index returns. In fact, over the past 10 years, capital has detracted from the total return generated by South African property and bond indices, while reinvested dividends are typically responsible for approximately one third of cumulative total returns for SA equities, as evidenced in Figure 1. Importantly, this is at an index level and does not represent the opportunities available at an individual security level to bottom-up stockpickers. While we do not have index data going back 10 years for South African investment grade corporate credit, we would expect the picture to be similar to that of government bonds, being that the income received exceeded the total return due to a portion of capital being lost to corporate defaults.

Current income environment

Official interest rates have been cut to very low or negative levels in most developed countries and the South African Reserve Bank (SARB) has rapidly followed suit. Year-to-date, the SARB’s Monetary Policy Committee has cut the repo rate by a substantial 3%, from 6.5% at the start of the year to the current rate of 3.5%. This collapse in the repo rate will have a material impact on the returns investors can earn from money market and cash-like investments; we can expect the average money market unit trust fund to trend down towards the current repo rate of 3.5%2. And while South African government bond yields have spiked, this is not entirely a good thing as it reflects an increase in the perceived risk of lending to the South African (SA) government.

At the same time, in the wake of Covid-19 and the related recession, many companies have suspended the payment of dividends. Globally dividends were down 22% in quarter 2, 2020, the biggest 3-month fall since 20093. Share buyback programmes have also been widely halted. In South Africa, the South African Reserve Bank went so far as to advise SA banks to preserve capital by not paying dividends, and real estate companies are deferring dividends as they attempt to shore up their balance sheets. Glencore, Capitec, Investec, Redefine, Rand Merchant Bank and Sasol are all examples of companies that have suspended the payment of dividends this year. Unfortunately, quantifying the resultant economic damage will take considerable time and therefore it is too early to know when many of these companies will be able to reinstate their dividends.

Simply put, the income desert has come to South Africa.

2 – See Cash trending towards trash, May 2020.

3 – Janus Henderson.

Preventing desertification requires an innovative approach

As a drastic response to the growing desertification of western and north-central Africa, countries across the region implemented the extraordinary idea of transforming their degraded landscapes through a “Great Green Wall” stretching across the width of Africa, from Senegal in the West to Djibouti in the East. The aim of this Great Green Wall of trees 10 miles wide and 4 350 miles long is to create a barrier against climate change and for it to form a transitional zone between the arid Sahara Desert to the north and the belt of humid savannas to the south.

Investment managers, on behalf of financial advisors and investors, will need to look to a similarly innovative response to ensure real returns for conservative investors. Fortunately, there are attractive opportunities across a range of asset classes and underlying securities, which continue to be identified and exploited by the Ninety One Quality capability’s structured, disciplined and effective investment approach.

In constructing portfolios, the Quality team seeks to balance risk and returns, and considers more than just income (and any potential for income growth) when evaluating individual securities within the various local and offshore asset classes available to them – equities, bonds, credit, property and cash. Where appropriate they also consider the potential for any capital appreciation and the impact of any currency movement in calculating the individual security’s expected total return, increasingly important in this lower yield world. Understanding how the various securities and asset classes behave in a holistic portfolio is also a key consideration, as is considering any downside sensitivities.

By way of example, the US dollar acts as a through-the-cycle shock absorber for SA portfolios and there is a negative correlation between SA bonds and high-quality global equities.

The Ninety One Cautious Managed Fund

The Ninety One Cautious Managed Fund (the Fund) is the ideal vehicle for investors who require a low risk, conservative investment option that still has the potential to beat inflation substantially and take advantage of rising markets. The Fund has a strong focus on capital preservation and absolute returns driven primarily by income through active asset allocation and stock selection decisions; the Fund’s impressive track record is evident in figure 2 below, which illustrates that the Fund has only had 1 negative 18-month return out of 151 rolling 18-month periods.

Past performance is not a reliable indicator of future results, losses may be made. Source: Morningstar, dates to 30 June 2020, performance figures above are based on lump sum investment, NAV based, inclusive of all annual management fees but excluding any initial charges, gross income reinvested, fees are not applicable to market indices, where funds have an international allocation this is subject to dividend withholding tax, in South African Rand. * Inception date 31 March 2006. Annualised performance is the average return per year over the period. Individual investor’s performance may vary depending on actual investment dates. Highest and Lowest returns are those achieved during any rolling 12 months over the period specified. Since inception: Feb-10: 23.8% and Feb-09: -6.8%. The Fund is actively managed. Any index is shown for illustrative purposes only.

Rather than trying to outperform other conservative funds or the market, the portfolio manager aims to achieve inflation-beating returns at the lowest possible risk – the fund targets inflation plus 4% over rolling 3 years. When making investment decisions the possibility of losing money is a more important consideration than the potential investment gain. This risk-cognisant approach is not only reflected in our approach to asset allocation, but also in terms of our equity stock selection.

Current positioning

In a recent report back, co-portfolio manager and head of SA Quality, Duane Cable, emphasised that we continue to focus on the highest quality opportunities. In the context of South African assets this means select government bonds, given the high coupon (real yield of approximately 6%) and resultant attractive risk/return characteristics, especially compared to SA equities and cash (and even considering downside risks to the fiscus). We then balance this with growth assets in the form of high-quality global equities with low leverage and low economic sensitivity. We favour those businesses that generate high and sustainable returns on invested capital in excess of their cost of capital. Importantly, these quality stocks tend to outperform in difficult market circumstances because of their balance sheet strength and more resilient earnings. Validating the strength of this approach, Microsoft, which is the second largest offshore holding in the Ninety One Cautious Managed Fund, has joined the list of top 10 global dividend payers for the first time.

In summary, we do not believe it appropriate to position the Ninety One Cautious Managed Fund for any event or crisis. Instead, we maintain a balance of exposures which offers protection against a range of potential outcomes, while generating inflation-beating returns over the medium to long term. As always, we remain unwavering in our commitment to growing capital in a prudent manner.

Paul Hutchinson

Sales Manager

Important information

All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Ninety One Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. Additional information on the funds may be obtained, free of charge, at www.NinetyOne.com. Ninety One SA (Pty) Ltd (“Ninety One SA”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). Investment Team: There is no assurance that the persons referenced herein will continue to be involved with investing for this Fund, or that other persons not identified herein will become involved with investing assets for the Manager or assets of the Fund at any time without notice.

Investment Process: Any description or information regarding investment process or strategies is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective. In the event that specific funds are mentioned please refer to the relevant minimum disclosure document in order to obtain all the necessary information in regard to that fund. This presentation is the copyright of Ninety One SA and its contents may not be re-used without Ninety One’s prior permission.

You can’t predict but you can prepare

The importance of good saving habits

As we emerge from the stringent lockdown restrictions of the past 100 plus days, many of us are now facing a world that looks quite different from what we were used to merely months ago. For many of us, things have changed drastically, especially financially. With July being “National Savings Month” in South Africa, it is perhaps time to pause and dwell a bit on the topic of savings.

 

Countless individuals have been faced with and/or might still face retrenchment, having to take unpaid leave, drastic salary cuts or the possibility of losing their business. This reality hits home hard. Due to the unforeseen and devastating aftermath of the Covid-19 pandemic, many individuals have been forced to tap into their savings. The current circumstances have made people acutely aware of how important it is to have an emergency fund and/or contingency plan.

 

With this in mind, let’s unpack the famous words of the well-known investor, Howard Marks: “you can’t predict but you can prepare”.

 

Prediction is a fool’s game

The first point to highlight is that trying to predict the market is fool’s game, however, it is human nature to try to find comfort in some sort of prediction of an outcome. This is because humans like to think they know what is going to happen next.

 

Using a very simple mathematical example, the below equation illustrates how the odds are against you when trying to predict an outcome. Firstly, you have to predict the event correctly, and secondly, you have to predict how the market will react as a result of the event. If you don’t get both right you won’t be able to capitalize on the opportunity. Let’s say you are exceptionally good at predicting and you get it right 70% of the time, the odds are still the same as flipping a coin.

 

Probability of predicting the event correctly x Probability of predicting the market’s reaction correctly

= 70% * 70%

= 49% (same odds as flipping a coin)

 

The table below details two examples of recent events that an investor could have predicted accurately, but most people got the second prediction – how the markets will react – wrong.

 

 

As we reflect on the events of the past couple of months, one thing is certain: it was impossible to predict the events that have unfolded this year and the resulted reaction of markets, governments and economies.

 

The only thing we can do is to do our best to prepare for times like these.

 

Preparing for the unknown

In a world filled with randomness and uncertainty a far better strategy than to prepare for the unknown is to focus on the known. What is known is that there are three primary drivers of results in life:

 

1) Your luck (randomness).

2) Your strategy (choices).

3) Your actions (habits).

 

Only two of these three drivers are within your control – your strategy and your actions. By focusing your efforts on your choices and habits, you take ownership of your finances, instead of leaving it up to chance.

 

The best way to prepare for these unknown and unprecedented times is to build up a nest egg. The most obvious way of doing this is by saving and taking advantage of the power of compounding.

 

In the words of Warren Buffett – “Do not save what is left after spending but spend what is left after saving”. Unfortunately, many investors tend to spend first and save what is left. Often these investors also make the mistake of not saving the little that is left, as they believe it won’t make a difference.

 

In January 2020, Victoria Reuvers, managing director of Morningstar Investment Management South Africa wrote an article in which she shows that anyone has the ability to become a millionaire. What it requires are two simple, but not easy, habits – firstly, start and stick to the habit of saving and secondly, be patient. Most investors’ path to becoming a millionaire is not by investing in the next big thing and making a quick buck overnight. For most of us, it is about building good habits and being disciplined when it comes to saving – even if it is just R200 a month.

 

We encourage investors to use July as an opportunity to re-think their budget, savings and spending habits and encourage their children to practice good habits from a young age. Think about a good savings habit like brushing your teeth. Twice a day for two minutes is all it takes, and although it may not feel like a big action at the time, the long-term positive effects are enormous. The problem when you don’t do it is that you only see the damage your poor habits have caused after a long period of time.

 

Some practical ideas to start saving

In South Africa, you can save R36,000 per annum in a tax-free savings account, and a maximum of R500,000 over a lifetime. This is probably the easiest vehicle to ensure you get the benefit of investment returns without the concern of a tax bill at the end of the financial year. Another effortless way to save is to set up a monthly debit order to an investment account. Not only do you then save first and spend after saving, but you also have the option to increase this amount annually and/or make lump sum contributions as well.

 

Other tips to start saving money every month:

  • Assess what you are paying in bank charges and if you are using all the additional services. You can perhaps switch to a cheaper offering.
  • Contact your insurance provider to re-negotiate your monthly premium.
  • Cancel any memberships that you don’t use.
  • To save electricity consider replacing all your lightbulbs in the house with energy-efficient ones and use gas appliances where possible.
  • Reduce discretionary spend: Try to buy clothes, furniture, appliances and other discretionary items only when they go on sale and don’t buy these items on credit.
  • Buying groceries in bulk can greatly reduce your grocery bill.
  • When going on holiday, shop around for special deals on flights and accommodation and search for discount coupons in the area that you are visiting.

These are just a few examples and there are many more ways to save a couple of Rand every month. Don’t ever think that it is too little to have an impact. There is a lot of power in compounding value.

 

Conclusion

In unusual times like these, investors might feel vulnerable and powerless. But it is often during times like these that we should try to form new healthy habits and leave behind bad habits. Let’s try to kick the practice of trying to predict everything and kickstart the habit of saving, even if only in small increments.

Debra Slabber, CFA®

Business Development Manager

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Start of a bull rally or more volatility to come?

We live in eventful times. During these tough economic times, it can certainly feel like the glass is half empty. The disconnect between the current economic environment and the recent rally in equity markets has left many people scratching their heads. Is this the start of a strong bull market or merely a slight recovery from the aggressive sell-off we saw in March 2020?

The world was overturned in March when outbreaks of Covid-19 started accelerating and affecting most markets across the globe. This saw almost one-third of the world’s population going into lockdown and many companies coming to a complete standstill.

 

During this time most financial markets sold off aggressively due to the uncertainty around the effect on businesses both locally and abroad. This resulted in some of the most aggressive local and global sell-offs seen in history and, in turn, also resulting in one of the fastest sell-offs in history. With this being said – in the weeks post 18 March, markets have also seen some of the strongest returns, resulting in most equity markets clawing back most of its losses.

 

So, the question begs, is the sell-off/risk-off trade done?

Let’s look at previous sell-offs and their subsequent recoveries in the South African equity market, namely 1998 (emerging markets) 2003 (technology) and 2008 (financial crisis) as well as 2020.

 

The graph below demonstrates the four above mentioned crises, the time the sell-offs started and the period it took for all capital losses to be recouped.

 

In other words, if an investor invested R100 on the day the sell-off started, the below graph shows how long it took (measured in days) the investment to reach the bottom (lowest amount) along with the subsequent recovery (in other words, how long it took for an investor to get back to the initial R100 investment). The x-axis signifies the number of days and the y-axis the change in the value of the initial R100 investment.

 

 

From the above graph, it becomes clear that the most recent sell-off was one of the most aggressive sell-offs, but the rebound has also been one of the quickest.

 

So, is it the end? Unfortunately, it is unlikely. Remember that share prices reflect the future earnings expectations of companies. So while prices of shares might have adjusted, companies haven’t realised earnings yet. There might still be some further headwinds that the market will have to digest as companies release their earnings results and the real impact of the lockdown is realised.

 

From the above graph, we can see that it can take anything from 190 days to 600 days to make up previous losses. You can get cycles during a 12-month time frame that feel like they should actually be playing out over the course of 12 years.

 

Once you start digging into the historical numbers you begin to realize the equity market is even more unsystematic than advertised. Surprisingly, huge up and down moves happening in the same year is not out of the ordinary.

 

Investments with more cyclical equities (such as airlines, banks and energy companies, to name but a few) are typically more volatile. That’s because a share’s return is based on the business’ profitability, which is difficult to predict. In uncertain market environments, like the current one, investors tend to be especially pessimistic about how businesses will perform, which can result in an overreaction (to the downside) in the share price.

 

So, why would you want to own equities when there is so much uncertainty? Because you’re likely to be rewarded with a higher return over the long haul if you can remain calm and stomach the volatility and noise.

 

When your portfolio’s value has declined amid this volatility, you might think that you’ve taken on too much risk. However, you shouldn’t necessarily conflate volatility with risk. Risk could be better defined as the permanent loss of capital (which is realised if you exit at a low point) and the chance that you won’t meet a financial goal. Even though a portfolio that is heavily tilted toward equity might bounce around in volatile environments like this, your total portfolio asset allocation might not be overly risky.

 

By reducing your exposure to more volatile or “risky” assets such as equities, you could significantly limit your portfolio’s potential return over the long run. If you have decades left to invest, a lower return could prevent your rands from multiplying at the necessary pace to reach your investment goals.

 

It’s easy to overplay the significance of volatility because it means we can address the overwhelming feelings of anxiety that occur in times of market stress. But with volatility comes opportunity, especially for the patient and sensible investor. Ultimately, equity market gains have offset shorter-term losses during market turmoil, and market volatility can be an opportunity to buy equities at a low price.

Eugene Visagie, CFA®, FRM®

Client Portfolio Manager

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Don’t let financial jargon throw you off your game

What to understand about downmarket jargon.

Market downturns leave many investors hopeless for various reasons. Portfolio values and income levels that have declined, the confusion as to what to do about it, a bombardment of information from various sources, and explanations by industry experts using terms you have never heard before. How should you know what to do if you don’t even understand what the problem is in the first place?

While it is impossible to control what happens in markets, you can make sense of these events by gaining a better understanding of relevant investment terms. In the following article, we look at a few financial terms that are often used during market downturns with the hope of assisting investors to make better sense of the myriad of terms being used.

 

Recession

The term “recession” in its strictest definition means that an economy experiences two consecutive quarters of negative economic growth as a result of a significant decline in general economic activity.

During a recession, businesses experience less demand (i.e. they sell fewer products and/or services). These businesses then usually react to this by cutting costs and sometimes laying off staff in order to protect the bottom line and profitability of the business. When staff are retrenched, this leads to higher unemployment rates.

Generally, a recession does not last as long as an expansion does. Historically, the average recession (globally) lasted 15 months, compared to the average expansion that lasted 48 months.

Causes of a recession can vary. While COVID-19 has certainly put a drag on the global economy, it remains to be seen whether it will have lasting effects on economic output. It is important to realise that recessions are a normal part of an economic cycle and every person will experience a few in their lifetime.

 

Bear Market

A bear market is when a market experiences a decline of at least 20%, usually over a two-month period or longer. Bear markets often arise from negative investor sentiment because the economy is slowing or due to the expectation that it will slow down. Signs of a slowing economy may include a decrease in productivity, a rise in unemployment, a decrease in company profits and lower disposable income. When someone talks about having a “bearish” view, it means they have a pessimistic outlook.

While a recession and a bear market often go hand in hand they are associated with different issues. The distinction between a bear market and a recession is that a recession is measured by a decline in economic output (also known as gross domestic product or GDP), whereas a bear market is identified by a decline in stock market values in excess of 20% over a prolonged period as a result of negative investor sentiment.

Some other terms that you might come across when reading up on market downturns include:

  • A pullback, which is a short-term price decline within a longer-term trend of price increases.
  • A correction, which is when an asset’s price falls by at least 10%.
  • A market crash, which is a drastic market decline over a short period.
  • A depression, which is a long-term recession that can last multiple years.

 

Volatility

Markets have been highly volatile of late, meaning equity prices have bounced up and down rather severely from one day to the next. Volatility marks how much an investment’s price rises or falls. If an investment’s price changes more dramatically and/or more often, it’s considered more volatile.

Price volatility is usually expressed in terms of standard deviation, or how much an investment’s price has fluctuated around its average price over a certain period. A higher standard deviation implies an investment’s price is more volatile.

Investments with more uncertain outlooks, like equities, are typically more volatile. That is because equity returns are based on a company’s profitability, which is difficult to predict. In uncertain market environments, like the current one, investors tend to be especially pessimistic about how businesses will perform, which can result in steep market declines.

So, why would you want to invest in a more volatile investment? Because you are likely to be rewarded with a higher return over the long-term.

 

Risk

Volatility and risk are terms often used interchangeably, although they are very different. Risk should be defined as “permanent capital loss” or the chance that you won’t meet your financial goal.

For a retiree, one risk might be not taking on enough risk. By reducing your exposure to more volatile or “risky” assets such as equities, you could significantly limit your portfolio’s potential return over the long run. By remaining in cash for prolonged periods of time you run the risk of increasing your tax bill significantly (due to interest earned being fully taxable) or losing purchasing power due to the eroding effects of inflation.

Even though a more equity orientated portfolio will experience more volatility in environments like what we are facing now, your asset allocation might not be overly risky. If you’re far away from retirement, you have time to ride out your portfolio’s short-term volatility and take advantage of longer-term gains that equity markets will generate.

 

Loss Aversion

Loss aversion is the theory that investors feel more pain when they lose a certain amount of money than they feel pleasure when they gain an equal sum. In other words, you would feel more discomfort from losing R1,000 than pleasure from gaining R1,000.

Time and time again it has been proven that selling your investments in a downturn and giving up on your long-term financial plan is detrimental to a successful investment outcome.

 

So where does that leave investors?

Things might not be so hopeless after all. Recessions, bear markets, drawdowns and volatility are all part of the world of investing and building long-term wealth. What matters most is our actions and habits during this time. These can either hurt you or help you, but most importantly always remember that “this too shall pass”.

Debra Slabber, CFA®

Business Development Manager

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Business finance man calculating budget numbers, Invoices and fi

TFSAs – helping to maximise your retirement income and minimise your estate duty liability

After 20 years, TFSA investors realise an additional 20% return due to these tax benefits.

Tax-free savings accounts (TFSAs) are a great initiative from government to encourage savings in South Africa. Jaco van Tonder,1 Advisor Services Director at Investec Asset Management, has previously discussed how to maximise the value of the TFSA tax benefits, which are well documented. You pay no tax on dividends and interest received, and no tax on capital growth. As a result, you benefit from increased compounding of returns. Jaco’s article shows that after 20 years, TFSA investors realise an additional 20% return due to these tax benefits. But little continues to be said about the potential retirement and estate planning tax benefits.

 

The first choices

Anyone retiring from a provident, pension, provident preservation, pension preservation or retirement annuity fund needs to decide what portion of their retirement benefits they would like paid out as a cash lump sum.

  • Provident and provident preservation fund members can currently2 elect to have their entire retirement benefits paid out as a cash lump sum.
  • Pension, pension preservation and retirement annuity fund members can elect to have up to a third of their retirement benefits paid out as a cash lump sum.

Where there is a balance remaining, this must be used to purchase an annuity, either a guaranteed or living annuity, which pays a monthly income that is taxable at the annuitant’s marginal tax rate.

 

How can a TFSA help reduce this potential income tax liability?

A TFSA can help a retiring member who has chosen a living annuity reduce their marginal tax rate, hence maximise their after-tax income.

A living annuity is a compulsory purchase annuity offered by insurers, retirement funds and linked investment service providers under which the income is not guaranteed but is dependent on the performance of the underlying investments. Importantly, living annuity regulations allow the annuitant to elect an income of between 2.5% and 17.5% per annum. However, research indicates that annuitants should not exceed an annual income rate of 5%, otherwise they risk ruin.3

1 TFSAs – how to maximise the value of the tax benefit? Taking Stock Spring 2017.

2 Changes to the tax treatment of provident funds, introduced as part of broader retirement reforms in 2015 by National Treasury, have been postponed. The proposal is that on retirement, members of provident funds will only be permitted to take up to a third of their retirement benefit, with the balance used to purchase an annuity, i.e. provident funds will be treated the same as pension and retirement annuity funds. The proposed changes will only apply to contributions made to a provident fund after the implementation date.

3 A sensible income strategy is critical for living annuity investors. Jaco van Tonder, Taking Stock Winter 2018.

Having established the income required in retirement, retiring members next need to determine how to access this income in a tax-efficient manner. As indicated above, a minimum income rate of 2.5% per annum must be taken from the living annuity, taxable at the individual’s marginal tax rate. Any income required in excess of this 2.5% can then be drawn from the TFSA. This income is not taxable and therefore minimises the retiring member’s marginal tax rate, as long as capital remains in the TFSA.

Drawing additional income from a TFSA means more money in your pocket for the same level of gross income drawn from the living annuity and TFSA combined.

This is best illustrated by a simplified example. Assume an investor has accumulated R1.8 million (as suggested by Jaco’s article)1 in his TFSA over the preceding 20 years and R7.5 million in his pension fund, which he then converts entirely into a living annuity. He requires an annual income of R350 000 and his only source of income is his TFSA and living annuity.

Below are two scenarios based on the 2020 income tax tables:

  1. In year 1 he takes the full R350 000 from his living annuity (a drawdown rate in year 1 of 4.67%). He will pay income tax of R77 539.50 and receive an after-tax income of R272 460.50.
  2. In year 1 he takes the minimum 2.5% from his living annuity (R187 500) and the remainder from his TFSA (R162 500). He will only pay income tax of R33 750 and receive an after-tax income of R316 250, i.e. a tax saving of almost R44 000 in year one and which, depending on the changing tax tables, is likely to escalate each year for so long as there is value in the TFSA.

Maximise the compounding growth of your retirement capital

Not only does this strategy reduce your marginal tax rate but it also ensures that your living annuity capital continues to compound faster, as your capital is eroded more slowly than it would be were you

drawing more than the minimum. Importantly, as with TFSAs, no income or dividend withholding tax is levied in the living annuity and capital gains tax is not applicable in terms of current legislation – only income paid by the living annuity attracts tax. As is the case for TFSAs, retirement capital invested in living annuities therefore benefits from increased compounding returns.

Minimise any estate duty liability

Estate duty is an important consideration for investors. On death, it would be preferable from an estate duty perspective to have depleted your TFSA (and other discretionary savings), while maximising the capital growth of your living annuity. This is because you may nominate a beneficiary or beneficiaries to receive the benefit on death, which in turn confers tax benefits on them. Beneficiaries may choose to receive the benefit as an annuity, a lump sum (subject to tax) or a combination of the two. Both lump sum and annuity benefits are free from estate duty. Bear in mind that disallowed contributions (retirement fund contributions in excess of a maximum allowable deduction) may be subject to estate duty where such contributions were made after 1 March 2015.

We encourage financial advisors and investors to carefully consider all the financial, retirement and estate planning benefits that TFSAs provide, including when used in combination with living annuities. By investing in a TFSA with Investec IMS, investors benefit from a competitive fee structure, transparent pricing and a wide range of funds from Investec Asset Management.

 

Investec IMS TFSA fast facts

These benefits are increasingly being recognised, as illustrated by the following summary data of the Investec IMS TFSA as at 31 December 2020 (31 December 2019 details in brackets):

Important information

All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). A feeder fund is a fund that, apart from assets in liquid form, consists solely of units in a single fund of a collective investment scheme which levies its own charges which could then result in a higher fee structure for the feeder fund. The fund is a sub-fund in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act. This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Investment Management Services (Pty) Ltd and Investec Asset Management (Pty) Ltd are authorised financial services providers. Issued, January 2020.

Make 2020 your start to becoming a millionaire

When asked who wants to be a millionaire, anyone would undoubtedly answer yes! However, the belief is often that this is impossible – unless through some stroke of luck or good fortune you get a windfall of money. We would like to disprove this theory and show you that it is indeed possible to become a millionaire through diligent saving.

What it requires are a few simple, but not easy, habits.

1) Start and stick to the habit of saving
2) Be patient

At Morningstar, we did some work to look at the amount of time it would take for your investment to grow to R1 million based on two factors –

 

Factor 1: The amount of money saved each month.

We looked at realistic contributions starting at R200 per month. R200 per month is equal to sacrificing roughly two coffees per week. A small sacrifice in the quest to become a millionaire. The monthly contributions used in our analysis ranged from R200 per month to R10,000 per month.

Factor 2: The return generated from your portfolio.

As investors, we naturally want the best performing portfolio and believe this is what will make the difference in our journey to wealth creation. (Park this thought for a moment as we are going to show you something very interesting in our analysis and return to the focus on performance.) The analysis used a range of return outcomes varying from the current return investors can achieve by putting their money in a bank account up to a maximum of 17% per annum. Realistically, many investments can deliver higher returns in short periods of time, but 17% per annum was considered a large annual return and a prudent maximum, as delivering such a strong outcome would require some meaningful risk-taking.

The table below shows the number of years it takes for your investment to reach R1 million based on the two variables above – your monthly contribution and the annual return thereof. Please note, it is a broad simplification and does not account for inflation and assumes a constant return and a constant contribution.

There are two interesting observations from this exercise. The first is that even with a mere R200 monthly saving into a savings account at the bank and generating a return of 6% per annum, if you start early enough, you can build your wealth up to R1 million. It may take you 55 years, but it proves that starting the habit of saving and being patient works.

The second observation is that if you look at the far right-hand column, you can see that by saving R10,000 a month, you reach that R1 million goal quickly and the return from your portfolio (on the left-hand axis) did not materially affect the time taken to become a millionaire. The power of compounding and the large contributions made all the difference.

This brings us back to the point raised earlier about focusing purely on performance. Yes, performance is important, particularly when monthly contributions are small, but what this exercise shows is that, more important than performance, is a consistent contribution and the size of the monthly contribution. I will agree with those who say R10,000 per month is a lot to invest, but even if you scale down to R1,000 per month, the goal of becoming a millionaire ranges from 17 to 33 years.

It is, of course, also important to remain mindful of the risk associated with investments. The above analysis assumes that your returns are achieved in a straight line, which is seldom the case. To achieve more than cash, it is likely you’ll have to absorb at least one setback in your wealth journey, which can distort the outcome. With that said, remember to focus on the long-term goal and not to be deterred by short-term market movements.

In the words of Elizabeth Gilbert – “There’s a wonderful old Italian joke about a poor man who goes to church every day and prays before the statue of a great saint, begging, “Dear saint-please, please, please…give me the grace to win the lottery.” This lament goes on for months. Finally, the exasperated statue comes to life, looks down at the begging man and says in weary disgust, “My son-please, please, please…buy a ticket.” The same goes for saving!

Bottom line, it is both possible and plausible to generate R1 million in savings by changing our behaviour. It starts with the decision to save on a monthly basis with no immediate gain in sight. The second behavioural change is practising the discipline of delayed gratification. Waiting. Patiently. And letting the eighth wonder of the world, compound interest, work its magic.

Victoria Reuvers

Senior Portfolio Manager

Morningstar Investment Management South Africa

Risk Warnings
This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.
This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure
The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Doctor with a stethoscope in the hands and hospital background

Coronavirus: An Investment Perspective

The Impact of Coronavirus for Investors

Public health outbreaks and epidemics like the recent coronavirus can quickly scare investors and, eventually, affect economies and businesses. The recent coronavirus outbreak has shut down airports, halted trade, and led to the rapid construction of new hospitals in China. The effects of the outbreak may push China’s economy into a period of slower growth, with stocks trading lower as investors seek protection.

 

So, what does that mean for the portfolios we run?

Key Takeaways

  • At Morningstar Investment Management, we are watchful. We continually monitor over 250+ markets, looking at everything from fundamental risks to contrarian opportunities.

  • Looking at nine major outbreaks since 1998, there is little evidence linking global epidemics with long-term investment fundamentals.

  • The Chinese economy may slow, perhaps even meaningfully, but that is not a reason to invest or divest. Long-term investing is often best disconnected from short-term economic reactions, so we implore investors to maintain their focus on what matters.

  • Across the portfolios we run, we do have a relatively small exposure to Chinese assets (both directly and indirectly) but remain confident these holdings will deliver positive outcomes for long-term investors.

 

Epidemics and Investing

To understand the potential impacts of an outbreak, we must make a forecast—formally or casually. This is a complex task if done correctly, and outside the scope of this piece. But it’s important to acknowledge that we’re trying to peer into the future, which is wrought with intellectual danger. No one can predict the future, but plenty of research suggest ways that forecasts can be improved.1

 

One way to improve the accuracy of a forecast is to start with base rates. How often do outbreaks become epidemics? What effect do epidemics have on economies or markets? For this latter question, we look to Exhibit 1 to provide a sense of base rates—market returns following major epidemics in recent history.

 

Exhibit 1 Investors Tend to React to Epidemics, But the Long-Term Picture is Positive

As depicted, market participants tend to react to such unforeseen outbreaks, but markets tend to recover by the six-month mark. This suggests that sentiment drives early losses, but sustained economic impacts are less than perhaps investors feared at the onset.

Another way to improve forecasts is through humility—especially knowing what you don’t and can’t know. Expert epidemiologists might be able to produce base rates on spread rates, mortality rates, and so on, but no one can predict how unknowable factors might affect the spread of this or any outbreak. That’s not to mention knowing how fear might affect markets.

 

So how can we make a reasonable assessment of the potential impact of the coronavirus? As long-term, valuation-driven, fundamentally based investors, our concern is any potential impact to businesses’ cash flows.2 For example, will the collective impact of the outbreak (fewer flights, less trade, loss of productivity, etc.) affect a few businesses, a few industries, or entire markets? That’s the question we’re asking.

 

Our answer is that, at this stage, we have to assume the outbreak will take a similar path to other recent epidemics, and thus we feel there’s no reason for investors to be alarmed. Note that there’s no “safe” approach for investors—for example, exiting stocks in favor of cash has its own risk, namely crystalizing any losses suffered to sentiment while almost surely missing out on a rebound if the virus were to be contained quickly. So we want to proceed by assuming what we consider to be the most likely scenario, while taking other possible outcomes into account.

 

Ultimately, we are very watchful but aren’t taking any action. Our core ambition is to help investors reach their goals, which requires a measured and repeatable process to investing. Across our portfolio range, we may hold exposure to Chinese stocks, emerging-markets stocks, emerging-markets debt, and companies that sell into China to varying degrees depending on the portfolio mandate. Even so, we are still expecting that these holdings will deliver positive outcomes over the long term, and it would require a clear impact to fundamentals for our view to change.

 

Note that once the facts change, we would expect to change our minds. If we were to see a clear and significant potential impact to investment fundamentals, we would carefully study the situation, conduct rigorous scenario analysis, and try to incorporate the new information into our portfolios. Until then, we remain vigilant.

 

Final Thought

With lives at stake, it would be uncaring to call the coronavirus “noise.” Yet, if we focus on the investor’s perspective, we believe it is not time to act. Moreover, we remain confident in our portfolio holdings because they reflect a solid base of research and resemble a well-reasoned way to invest. We certainly won’t be hitting the panic button and we hope you won’t either.

 

Further information

If you have questions on discussions in this piece or want to propose a pressing question for our investment staff, please contact your financial advisor.

 

Since its original publication, this piece may have been edited to reflect the regulatory requirements of regions outside of the country it was originally published in.

 

About Morningstar, Inc.

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors in the private capital markets. Morningstar provides data and research insights on a wide range of investment offerings, including managed investment products, publicly listed companies, private capital markets, and real-time global market data. The company has operations in 27 countries.

About the Morningstar Investment Management Group

Morningstar’s Investment Management group, through its investment advisory units, creates investment solutions that combine award-winning research and global resources with proprietary Morningstar data. With more than USD$220bn in assets under advisement and management as of 30 September 2019, Morningstar’s Investment Management group provides comprehensive retirement, investment advisory, and portfolio management services for financial institutions, plan sponsors, and advisers around the world.

Morningstar’s Investment Management group comprises Morningstar Inc.’s registered entities worldwide including: Morningstar Investment Management LLC; Morningstar Investment Management Europe Limited; Morningstar Investment Management South Africa (Pty) Ltd; Morningstar Investment Consulting France; Ibbotson Associates Japan, Inc; Morningstar Investment Adviser India Private Limited; Morningstar Investment Management Asia Ltd; Morningstar Investment Services LLC; Morningstar Associates, Inc.; and Morningstar Investment Management Australia Ltd.

 

Important information

The opinions, information, data, and analyses presented herein do not constitute investment advice; are provided as of the date written; and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this document. Except as otherwise required by law, Morningstar, Inc or its subsidiaries shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. There is no guarantee that a diversified portfolio will enhance overall returns or will outperform a non-diversified portfolio. Neither diversification nor asset allocation ensure a profit or guarantee against loss. It is important to note that investments in securities involve risk, including as a result of market and general economic conditions, and will not always be profitable. Indexes are unmanaged and not available for direct investment. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

This commentary may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

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1 – See Superforecasting: The Art and Science of Prediction by Philip E. Tetlock and Dan Gardner. The Notes section cites numerous studies, including those done by Tetlock and his partner, Barbara Mellers.

2 – Note that as investors have a particular focus on fundamentals. As humans, we care deeply about the loss, suffering, and fear brought by this or any outbreak. But we mustn’t let our emotions drive investment decisions—now or in any circumstance.

Surviving the short term to thrive longer term

The current challenge facing many long-term investors is to simply survive the shorter-term market disappointments to benefit from the return premium offered by growth assets over the longer term.

For many investors, the last five years have been traumatic. Domestic woes and instability in global markets have resulted in muted returns across almost all asset classes.

 

Figure 1: A range of factors have led to disappointing returns

Source: Investec Asset Management.

While global assets have outperformed local assets, this outperformance is mostly due to rand depreciation, as evidenced in Figure 2. Over the five years to the end of October 2019, the rand has depreciated by as much as 7% per annum against the US dollar, thereby making up the bulk of the rand return for global cash and bonds and more than half the return for global equities.

 

Figure 2: Five-year annualised returns in rands to 31 October 2019

Market returns have proven a significant challenge for people drawing an income

A lack of retirement savings and depressed investment markets have left many pensioners anxious about the future. Jaco van Tonder, Advisor Services Director, has explored the challenges facing retirees as part of Investec Asset Management’s in-house research study into “How investors should approach living annuities”.1

Jaco makes the point that even though the principle of “beating inflation requires exposure to equities” is widely accepted by investment professionals, it is easy to overlook this principle in situations where an investment portfolio is required to produce an income. Jaco also makes two conclusions that are relevant to this article:

  1. Living annuities require meaningful equity exposures to enable the annuity’s income levels to keep pace with inflation.
  2. Fixed income portfolios are unable, on their own, to produce the returns required to keep pace with inflation.


Investing in the wrong asset class is costly in the long term

Despondent investors have increasingly sought refuge in fixed income investments, thereby potentially compromising their long-term investment goals. This behavior is even true for conservative investors who had previously invested in multi-asset low equity funds (i.e. lower risk funds that target inflation beating returns over rolling three-plus years), such as the Investec Cautious Managed Fund.

For long-term investors, however, investing in the wrong asset class can prove costly. The South African Savings Institute (SASI) makes the point that while in the short-term cash and bonds may be somewhat safer, in the longer term they provide less protection against inflation and therefore are unlikely to maintain real buying power.

 

1 – A new approach to living annuities: https://www.investecassetmanagement.com/south-africa/professional-investor/en-za/insight/living-annuity-an-active-solution/.

Furthermore, tax considerations generally accentuate this outcome. SASI’s analysis suggests that over time, the four domestic asset classes are likely to produce the following real (after inflation) returns in the long run:2

• Cash: 0 to 1%

• Bonds: 1 to 3%

• Property: 2 to 4%

• Equities: 7 to 9%

It is also important to note that with inflation well within the target range and developed market interest rates at all-time lows, interest rates in South Africa are likely to trend downwards. The attractive real returns offered by money market and other flexible fixed income investments are therefore likely to come under pressure as a result. At the same time, we are now far more optimistic on the prospects for growth assets to deliver inflation-beating returns in the future.

 

Targeting consistent real returns to conservatively grow your savings

We therefore continue to argue that conservative investors should reconsider the important role that multi-asset low equity funds can play in their portfolio. These funds offer a bias to income-generating assets, while maintaining a growth element.

The Investec Cautious Managed Fund, for example, is suitable for conservative investors saving for retirement and for retirees drawing an income from a living annuity. The fund is well-positioned to meet these needs, thanks to its broad investment opportunity set that allows for investment in assets that offer growth and income, and a strong emphasis on capital preservation. As a result, the Investec Cautious Managed Fund has delivered a positive real return over rolling three-year periods 80% of the time, as shown in Figure 3.

 

Figure 3: Growing investor capital in real terms

A key strength of the fund is its ability to exploit the changing investment opportunity set. Historically, multi-asset funds have looked to South African equities as the primary driver of real returns and offshore bonds as the uncorrelated defensive asset. However, we believe that offshore equities are now the best opportunity for growth, with South African bonds offering attractive risk-adjusted returns, as well as helping to counterbalance risk in the portfolio.

 

This view is reflected in the next two charts. Figure 4 shows the changing asset allocation of the Investec Cautious Managed Fund over time, while Figure 5 depicts the Quality capability’s range of expected returns over the next five years from the different assets held in our Quality portfolios, including the Investec Cautious Managed Fund.

 

Figure 4: Investec Cautious Managed Fund asset allocation since 2006

Figure 5: Range of expected annualised returns for current Investec Cautious Managed Fund holdings (in rands)

In conclusion

In today’s uncertain investment environment, asset allocation and stock selection are key. Conservative investors should consider entrusting a portion of their investments to the experienced, well-resourced and globally integrated portfolio management team who manages the Investec Cautious Managed Fund. To quote, Duane Cable, Investec Cautious Managed Fund Portfolio Manager: “In the volatile world in which we find ourselves, it has become increasingly apparent that one needs to have a global perspective to navigate the choppy waters of investment markets”.

Important information

All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The TER of the Investec Cautious Managed Fund (A) class is 1.73%. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is an authorised financial services provider. Issued, December 2019.