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.

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.

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.

Given the challenges the South African economy is facing and the underperformance of local risk assets relative to its global peers, one can appreciate why some investors are considering investing the bulk of their wealth in offshore assets. As the saying goes, discretion is the better part of valour, and investors would do well to remember to be cautious when making big changes to their investment portfolio(s).

Although times are tough and confidence is low, investors must remember to remain focused on the fundamentals and not be led by emotion. Fear and panic can force us as investors into making mistakes with our money. Buying quality assets at discounted prices not only gives investors the best chance of achieving superior returns in the long run but also offers a margin of safety, which is critical from a risk control point of view.

When we think about returns from a total return perspective, we believe total returns arise from three components:

1. Growth (i.e. growth in the earnings potential of the asset in question)
2. Yield (i.e. the cash flows – such as the dividends you receive – relative to the price of the asset)
3. Ratings change (the change in valuation i.e. the price appreciation/depreciation of the asset in question.)

When taking a closer look at the current return prospects of local and offshore assets, there is a range of factors to take into consideration from a valuation perspective.

On the global front, current yields for global assets are less compelling, in part due to asset prices being on the high side. These high prices (relative to historical prices) would suggest that, over time, the prices of these assets will move back to the mean (i.e. the average price). If investors were to buy in at current prices and the prices reverted to the mean, it would lead to investors losing value.

To be clear, we are not suggesting that a collapse in asset prices is imminent or is the next sequential step for global assets. Instead, we acknowledge the possibility that asset prices could rally further (i.e. become more expensive), which in our view, incrementally adds to the risk of capital loss.

Careful consideration needs to be given to risks that arise from having exposure to different geographies when you invest offshore. These risks range from currency to asset and liability mismatches. For instance, the currency tailwind that one enjoys when the rand weakens can easily be a headwind when the rand strengthens. Currency risk is significant and unpredictable when one considers the volatile nature of exchange rates. We remind investors that the rand can strengthen in the absence of positive local developments. The rand can easily appreciate on the relative weakness of major currencies, i.e. non-South African specific reasons. Risk should, therefore, be continuously monitored and managed.

Local asset prices have conservative growth estimates. The yield component is attractive owing to compelling dividend yields on the back of depressed asset prices. Further to this, there is potential for a reversionary re-rating to current multiples which could further enhance returns. But what of the dire situation the local economy finds itself in? How will companies grow earnings when there is a clear lack of demand and pricing power in the local economy?

A struggling economy does not necessarily equate to bad investment outcomes. Even in tough economies, there are well-run businesses that can maintain and grow profits. Some local businesses are well-diversified geographically in terms of both revenue and operations, which gives them exposure to offshore earnings streams and makes them less reliant on local macro conditions.

With that said, it’s also important to acknowledge that there will be losers amongst local businesses as some will struggle to cope with the macro-economic backdrop. The current scenario presents an opportunity for superior performance – for investors that are willing to discover and exploit good investment opportunities as well as tolerate the discomfort and stay the course.

It is especially during times like these that investors are faced with emotional and behavioural challenges on their investment journey. One of these challenges is dealing with and separating their emotions when it comes to making decisions about their investments. Most investors are, with good and admirable reason, emotionally invested in the affairs of our country, sometimes to the detriment of their investment decision making. They often fail to recognise good investment opportunities, due to the negativity surrounding the current status quo. We all need to strive to make rational decisions based on sound principles and facts, and not emotions if we are to increase our odds of investing successfully.

We urge investors to take a holistic approach when it comes to investing, i.e. to adopt a total portfolio approach to investing in order to diversify and minimize investment risk. Investors should strive for broad diversification and carefully assess the risk and reward characteristics that competing assets introduce to their investment portfolios.

While we see opportunities in select S.A. asset classes, in our regulation 28 compliant portfolios, we remain close to fully invested in global equities as part of our overall portfolio construction process to maximise the reward for risk.

Both local and offshore investments have their pros and cons. This is why it is important to have a well-diversified portfolio that will protect and grow your investments in a variety of different market conditions. Going forward, it would be advisable to place more focus on expected future returns and risk management. Investors must focus on remaining patient, staying the course and avoid making investment decisions in a panic.

At Morningstar, we continue to follow a valuation driven approach when allocating capital. This includes taking a holistic approach to portfolio construction, by allocating to unloved and cheap assets with a wide margin of safety. It is often during times when these assets are completely out of favour that the best opportunities for future returns present themselves.

Simbarashe Mangwiro

Associate Investment Analyst, 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.

The fear of an impending recession, low interest rates, U.S. strength, South Africa’s weak economy, and the negative implications of the ongoing trade war (to name but a few), have left quite a few investors at an impasse. Many investors are battling with the question “is now really a good time to invest?”. Despite all these concerns, we believe that now is a great time to invest – provided you follow a tried and tested investment process

At Morningstar Investment Management, we follow a valuation driven investment approach. This investment philosophy aims to identify cheap asset classes to invest in and limits exposure to expensive asset classes. Many factors are considered in understanding the valuation of asset classes. Evidence points, such as longer-term valuation, is evaluated as a key determinant of future returns. To avoid value traps, fundamental risk is also considered to ensure that we do not invest our client’s capital into asset classes that are cheap for the wrong reasons (as these assets will likely remain cheap).

If we consider the CAPE ratio (Cyclically Adjusted Price to Earnings ratio) think of it as an inflation-adjusted measure of how much you are paying for each unit of future earnings. Therefore, the higher the value, the more you are paying for further earnings. Currently, assets with a high CAPE value include US largecap tech stocks such as Apple, Alphabet and Amazon, to name but a few. In this instance, investors are assuming that the growth achieved by these companies over the last couple of years will remain intact for the foreseeable future. They are also therefore willing to pay more for the future earnings of the asset.

As illustrated in the graph below, and if history is anything to go by, expensive asset classes tend to underperform their cheaper peers. If we were to rank all asset classes into expensive (Q5) and cheap (Q1) and measure the returns over the next 10 years, we can see that cheaper asset classes tend to outperform their more expensive peers.

By creating a portfolio of asset classes that have lower CAPE ratio’s, it creates the possibility of such a portfolio to outperform in the foreseeable future. But what happens if there is a market sell-off and all asset classes decline in value? If we consider what happens to these assets in the event of a significant risk-off trade (in other words, the large sell-off of equities), the more expensive asset classes (Q5) sell-off more than their cheaper peers (Q1). The cheaper asset classes will inevitably lose some value as well but a portfolio with a 10% drawdown will recover meaningfully faster than a portfolio that lost more than 50% of its value.

So, where are we seeing opportunities and how are the Morningstar portfolios positioned currently? In global markets, U.S. large caps are relatively expensive when compared to other asset classes (Q5). Areas such as the UK, Japan and Emerging Markets (Q1) are presenting better opportunities.

Locally, we’re seeing opportunity in S.A. bonds and the S.A. industrial sector. Our analysis indicates that S.A listed properties are still facing significant headwinds due to an oversupply of both retail and office space.

What does this mean for clients and ultimately their investment goals? Thankfully, lower interest rates have supported most asset classes in recent years. Going forward, it would be advisable to place more focus on expected future returns and risk management. It is no secret that risk has increased of late, but we remain confident that our investment approach will deliver positive outcomes for your clients -irrespective of market outcomes.

Eugene Visagie

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.

In a recent article¹ we made the point that while investors are encouraged to remain invested through the cycle, there are several warning signals that should trigger the re-evaluation of their investment in consultation with their financial advisor. The article generated much interest, with advisors identifying the following additional triggers:

Significant cashflows in either direction over a short period of time may impact a portfolio manager’s ability to implement his investment philosophy. Monitoring cashflows is therefore important. In this regard, it is also important to understand how concentrated the ‘ownership’ of the fund is, as a fund with a few large investors could be materially impacted should one or more decide to exit.

Certain investment philosophies’ ability to deliver outperformance reduces as assets under management grow and portfolios become unwieldy. It is crucial that the asset manager has the discipline to close to new investments and not succumb to greed.

With managers now able to invest up to 30% offshore and a further 10% to Africa ex-South Africa (in respect of Regulation 28-compliant funds and funds classified by ASISA as South African portfolios²) it is essential that the managers demonstrate excellent, fully integrated investment capabilities, with local and offshore assets managed holistically. While some managers may outsource the offshore holdings in their South African portfolio, we believe it vital they are managed with full oversight by the South African fund’s portfolio manager(s), rather than as a bolt-on portfolio of vanilla assets benchmarked to a global index. Bolt-on, at best, does not enhance the risk/return tradeoff and at worst leads to unintended positions within the fund.

1 Viewpoint: When to sell? – September 2019.

2 ASISA Standard on Fund Classifi cation for South African Regulated Collective Investment Scheme Portfolios, 30.10.18.

The impact of capital gains tax (CGT), often overlooked

For discretionary investors, even if a warning signal has triggered, a further consideration is the early payment of CGT when making portfolio changes. Or is it? While often considered, the CGT impact is seldom quantified. However, this is an important exercise because when an investor disinvests intra-term and pays CGT there is the compounding opportunity cost of the tax paid. Simply put, an investor in the maximum marginal tax bracket who realises a capital gain of a R100 000 pays CGT of R18 000 (if he has already used his annual capital gains exclusion of R40 000). The opportunity cost to the investor is then the difference between the future growth on the full R100 000 (if he did not realise the investment) versus the growth on only R82 000. This opportunity cost is often missed in the investment planning process because the CGT on a portfolio rebalance is generally paid later in the year, and often from an investor’s other liquid assets.

Quantifying the CGT cost of portfolio changes

Now that we understand that the early payment of CGT may carry an opportunity cost, we have tried to answer the following question; “If an investor switches out of fund A and into fund B at some point during their investment term, what additional return is required from fund B to compensate the investor for the early payment of CGT?”

The answer to this question is not straightforward and depends on multiple factors, which include the returns and profile thereof delivered by fund A and B, the investor’s investment time horizon and at which point in the investment time horizon the investor decides to switch.

As an example, let’s compare the experience of two investors, Jack and Jill who invest a similar amount in fund A at the same time, and have an investment time horizon of 10 years. Fund A delivers a consistent return of 10% p.a. and Jack remains invested for the full 10 years, at which time he disinvests and pays his CGT liability. Jill, on the other hand, identifies one of the triggers detailed above and decides to switch out of fund A after 5 years. After paying CGT, Jill invests the remainder of her proceeds into fund B. Table 1 sets out the excess return per annum that fund B must deliver over the following five years so that Jill has the same fund value as Jack at the end of the 10-year term.

Table 1: Excess return required from fund B

The table above shows that, for an annual return of 10% p.a. from fund A, fund B needs to produce an additional 0.60% p.a. so that Jack and Jill finish on the same fund value after 10 years. This difference in return represents the opportunity cost of paying CGT after 5 years.

Fairly intuitively, our analysis indicates that:

• The required additional return from fund B increases as the return from fund A increases (as seen in the table)

• The longer the investment time horizon the greater the additional return required from fund B (e.g. doubling the investment term to 20 years increases the excess return required on fund B from 0.60% p.a. to 0.81% p.a.)

• The earlier into the investment time horizon you switch, the lower the additional return required from fund B and vice versa

Conclusion

The CGT impact of making changes to an investment portfolio should be carefully considered and quantified. The CGT impact can set a portfolio back and should therefore be evaluated against the expected benefit of the portfolio change. Given the multiple factors that will affect this decision, we strongly recommend that you consult with a qualified financial advisor and seek expert tax advice, as required.

For longer-term, higher marginal tax-paying investors it may prove beneficial to hold their underlying local investments in the Investec IMS Access sinking fund policy and for offshore investments in the Investec GlobalSelect Access sinking fund policy, as they will benefit from the lower CGT effective rate of 12% (for maximum marginal taxpaying investors).

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. Issued by Investec Asset Management, September 2019.

I believe that we are all guilty at times of being consumed by the pervasive negative news. In this article JP Landman writes an objective honest piece about what we are getting right.

“Just do something” is the cry now rising from all over SA, a plea to the President and government in general to take some action to break the logjam in which the country finds itself.  Confidence is low, growth sluggish and emigration high.  It is useful to recapture what has been done.

The Ramaphosa administration has set itself two tasks: to rebuild the ethical foundations of the state and revitalise the economy.  The two topics are too much to cover in one note, so I will discuss ethical renewal in this note (Act 1) and assess economic renewal in the next one (Act 2).

Cleaning up and re-building ethics

The country first and foremost had to be reclaimed from the forces of state capture.  Ramaphosa appointed four commissions of enquiry to help with the clean-up offensive.  Two are still in session (the ubiquitous Zondo Commission and the Mpati Commission into the PIC) and two have finished their work.  Between them the four has sparked considerable action – a lot of which we have already forgotten about.

Freeing critical institutions

It is useful to remember that both the erstwhile number 1 and 2 in SARS, Tom Moyane and Jonas Makwakwa, are gone.  So is that embarrassing former head of IT at SARS, Ms Makheke-Mokhuane, who made such a spectacle of herself on national television that she publicly apologised for it.  That is not all: in the last week of July three SARS executives were suspended.  The clean-up continues.  The EFF and the Public Protector are fighting a rear-guard action against SARS renewal with old allegations of rogue units and attacks on new Commissioner Kieswetter.  He is forging ahead unperturbed and can leave the Public Protector to the courts.

At the NPA the erstwhile top 3 have also departed and a woman with experience at the International Court in The Hague has returned to SA to take up the baton.  The departure of the three has freed the NPA from its era of Zuma capture and it is being rebuilt.  (One is fighting her dismissal in court and two have appealed to Parliament not to be fired.  It will be an interesting test case for who is in charge in Parliament.)

Director Batohi took office in February. In March a special investigative unit to focus on cases arising from state capture revelations was formed.  In May Batohi brought in well-known corruption buster Hermione Cronjé to lead the new unit.  Like Batohi herself, Cronjé has international experience and returned to SA to take up the role.  A senior advocate from the Cape Town Bar, Geoff Budlender, has been appointed as strategic advisor to this unit.  Batohi has re-appointed Willie Hofmeyr as head of the asset forfeiture unit after he was side-lined three years ago by the Zuma squad.  I wrote in this newsletter in April that 2020 will be the year of prosecutions and I explained why then. I stick with that call.

Over at the Hawks both the former head and acting head have been fired and replaced by the soft-spoken and highly regarded general Godfrey Lebeya.  His influence is showing: two captains and a warrant officer from the Hawks were arrested for bribes.  In Durban both the mayor and a councillor have been arrested by the Hawks and have appeared in court (with the usual tweet from Zuma supporting the mayor and with her supporters protesting outside the courthouse).  Two senior officials from the Durban Metro were also arrested.  A mayor of Newcastle was arrested for an alleged (political) murder; as was a former mayor of Endumeni for alleged conspiracy to murder.  Not bad for an erstwhile Zuma and current ANC stronghold.  In the Free State nine civil servants and a director of a company was arrested and charged – one for interfering with the work of the Hawks. In Mpumalanga a former local ANC chief whip was arrested on corruption and fraud.  The Hawks are clearly at work.

In Limpopo the VBS report claimed the scalps of five mayors who resigned, four more who were fired and three who were suspended.  In North West three mayors resigned, one was suspended and three have taken legal advice to try and avoid dismissal. Public opinion counts – especially in the run-up to an election.

At SAPS a deputy-commissioner has been fired and six officers of general or brigadier rank have been charged.  As recent as last week seven junior officers were arrested for selling confiscated goods back to hawkers.  In a significant ruling one of the “untouchables”, former head of Crime Intelligence Richard Mdluli, was convicted in July on several charges for offences committed twenty years ago in 1999.  The wheels of justice turn slowly, but they turn.  (As John Block, the former ANC strongman in the Northern Cape and Zuma acolyte also discovered – after many legal manoeuvres he is now serving a 15-year jail sentence.)

The ubiquitous SOEs

The SOEs are still burning cash and their balance sheets are shocking, but on the ethical front a lot has happened.

At Eskom former big bosses Brian Molefe, Anoj Singh and Matshela Koko are gone.  Molefe has also been pursued by Solidariteit and must now repay R10 million to the Eskom pension fund.  365 Eskom managers were subjected to lifestyle audits, resulting in 44 cases being referred to the Special Investigating Unit.  More than 1 000 disciplinary cases were instituted, and 116 employees decided to resign, including 14 senior executives.  Of 25 employees who had “business interest in suppliers dealing with Eskom” seven resigned and the rest terminated their interests.  Eskom has seen a serious clean-up.

A year after the notorious Hlaudi Motsoeneng was dismissed from the SABC, three of his erstwhile henchmen are gone too.  (The verbose Hlaudi failed with court challenges to regain his job and then went on to fail again in his election efforts to get into Parliament.)  In an important self-initiated report published last week, compiled by veteran journalist Joe Thloloe, the broadcaster laid bare political interference in its editorial policy.  Former minister Faith Muthambi complained she was “rubbished” in the report … could not happen to a nicer person.  Expect further fallout from the Thloloe report.  A Zuma-appointed chairman in still in place at the SABC and the corporation wants a mere R3 billion to stay afloat, but cleaning up has certainly taken place.

The PIC saga is still on-going before the Mpati Commission, but already a new board is in place, the CEO is gone, and so are two senior executives.  A number are on suspension.  In an important break with the past, cabinet reversed the practice of a politician chairing the board.  Under new chair Reuel Khoza’s experienced leadership and rock-solid integrity the PIC will, with a little help from the Mpati Commission, clean up properly and head in a new direction.

At SAA the former Zuma acolyte Dudu Myeni is gone – in his second stint as Minister of Finance Pravin Gordhan desperately tried to get rid of her.  Now Zuma is gone, Myeni is gone, as are several former senior executives.  Everybody can see how the once-mighty has fallen.  Now there is only the small matter of staying afloat.

At Transnet five executives, including the CEO, departed and eight more are on suspension.  At Denel the CEO, finance chief and chair are all gone.  Both organisations have new boards.  It may not be enough to save them financially, especially Denel, but action has been taken against weak ethics.

Cabinet

Perhaps the biggest clean up took place in cabinet.

Ramaphosa inherited a cabinet of 36 ministers. There are now 28.  At most five of those can be described as Zuma- or Magashule-supporting.  (And even some of those will deny it.)  40 government departments have been reduced to 35.

For all the publicity that was given to erstwhile Zuma ministers who were appointed chairs of parliamentary committees, the numbers speak for themselves.  There are 36 committees in Parliament.  Traditionally the Select Committee on Public Finance (Scopa) has an opposition party member as chair. That is the case again in this parliament.  Of the remaining 35 committee chairs, 11 may be regarded as Zuma- or Magashule-supporting people.  Most of these are ministers who were kicked out of cabinet.  From a minister to a chair of a parliamentary committee where every move is watched by opposition parties … and now we are asked to believe that they are paralysing government …?

So What?

• Part of Ramaphoria was the belief that the bad guys would lose.  That is certainly happening.
• People who were once untouchable have fallen from grace for all to see.  Some have even been convicted already.  The impunity of the Zuma years is slowly being reversed.
• The process is not over with the Zondo Commission still in session and almost weekly revelations of bad-guy behaviour.
• Getting convictions in court is very different from revealing things at a commission. Despite that many people have already fallen on their swords.
• Civil society organisations have helped in this clean-up and that speaks volumes for SA’s democratic activism.
• In the next edition we will focus on the second priority of the Ramaphosa government – economic renewal (Act 2).

JP Landman

Political & Trend Analyst

What are ASISA’s views on prescription of assets and why?

When the term “prescribed assets” is used, it is understood to refer to Government forcing the savings industry to buy Government stock as well as bonds issued by State Owned Enterprises (SOEs) on behalf of investors like retirement funds. This concept was first introduced by the previous Apartheid government and has been raised periodically over the years by various political parties.

It did not work when introduced by the Apartheid government and ASISA and its members maintain that it would have negative effects on the country should it be introduced now.

The savings and investment industry, as represented by ASISA, has engaged extensively with various relevant parties on the potential impact of “prescribed assets”, including directly with Government Ministers tasked with infrastructure development, via Business Unity South Africa (BUSA) into the National Economic Development and Labour Council (Nedlac), and via the CEO initiative.

The Government under President Ramaphosa has been very collaborative as evidenced by the various engagements like the Jobs Summit, Investment Summit and the ongoing engagements with the CEO initiative. If “prescribed assets” are again tabled for discussion by Government, we believe engagements with our industry will be equally constructive.

ASISA is empowered by a mandate from members that manage some R6.2 trillion of the nation’s savings and investments and is therefore recognised as a significant and relevant partner around Government’s negotiation table. We regularly engage on a number of issues regarding policy, regulatory reform and other issues of national priority such as economic transformation and inclusion.

Why do we oppose “prescribed assets”?

• The concept of “prescribed assets” would force the savings and investment industry to deploy the savings of ordinary South Africans into entities that have over the recent past been mired in State Capture and lack of delivery. As custodians of these savings we have to oppose this.

• Asset managers are not asset owners. The bulk of the assets that could be prescribed are owned by retirement fund members. It also needs to be noted that roughly half of these assets are held by the GEPF and are therefore owned by public servants. As the owners of these assets, ordinary South Africans elect and appoint trustees to make asset allocation decisions that are in their best interest. Prescription would jeopardise this fiduciary duty.
• Prescription of assets interferes with the capital allocation function of the capital markets, which should always be objective and driven by performance. Forcing the market to invest in low yielding and/or high risk projects could have two direct consequences:

 – The incentive for these projects to compete would be removed as funding would no longer be incentivised by performance.

– Given that capital is a finite resource, deserving projects could be deprived of funding. These projects that would otherwise have driven growth and created sustainable employment would now not happen anymore.

• Prescription would have a negative impact on the country’s credit rating. If South Africa loses its investment grade rating, foreign investors, many of whom are pension funds, would be forced to withdraw their money from South Africa. This is something the country can ill afford.

Working with Government on infrastructure finance

ASISA has always maintained that the problem is not the lack of willingness of capital markets to invest, but rather the absence of viable projects. We are engaging with Government to address this with urgency.

ASISA and its members believe that many of our country’s challenges can be overcome through effective public private partnerships (PPPs).

ASISA was therefore represented by several of its Board members as well as senior policy advisers at President Cyril Ramaphosa’s Investment Conference last year, which took place under the theme “Accelerating Growth by Building Partnerships”.

ASISA is actively involved in working with Government on infrastructure finance for water, energy and student accommodation. We are also looking at collaborative delivery mechanisms with Government and the Development Bank of Southern Africa (DBSA) for programmatic financing solutions.

ASISA members have already deployed more than R1.3 trillion in support of Government, Local Authorities and State Owned Companies.

In addition, our industry has made direct investments of R200 billion into the following projects:

• Renewable energy
• Township development
• Affordable housing
• Urban regeneration
• Student accommodation
• Water
• Roads
• Agriculture (emerging farmers)

Investors are encouraged to stay the course, but look out for warning signals to re-evaluate a fund.

Generally, you should not alter your investment strategy or its execution unless it was incorrect at the outset, or your personal or financial circumstances change. At crucial points, such as when you get married, have children, get retrenched or retire, we strongly recommend that you consult a qualified financial advisor. Absent such change, the basic rule is: “Do not let shorter-term market fluctuations and negative market commentary sway your commitment to your long-term investment goals.” There is much research that supports the view that investor behaviour is a destroyer of investor returns¹, and that investors should “stay the course”.

Having said that, we believe that you should re-evaluate a fund in which you are invested if one of the following warning signals is triggered:

• Change in the portfolio manager(s) and/or the supporting analyst team

The portfolio manager is the key individual responsible for delivering on the fund’s stated investment objective. Prior to making your investment, you (together with your financial advisor) would have evaluated the portfolio manager’s ability to deliver on the fund’s mandate. A change in portfolio manager necessitates an evaluation of the new portfolio manager’s ability to continue to do so.

In most instances, a portfolio manager is supported by a team of investment analysts. It is likely that these analysts play a significant role in the fund meeting its investment objective over time. Therefore, changes to the analyst team also necessitate the re-evaluation of the fund.

• Evidence of investment philosophy drift

When selecting a fund to assist you in meeting your long-term investment objectives, you may have done so based on the portfolio manager’s investment philosophy, for example value, growth or momentum-focused. It may be that after a period of underperformance because the investment style has been out of favour (value underperformance comes to mind over the past eight or so years), the portfolio manager starts to drift away from his stated investment philosophy. This style drift will likely result in the fund neither meeting its investment objective over time nor fulfilling the role for which you selected it. This should therefore trigger the re-evaluation of the fund.

A fund such as the Investec Diversified Income Fund aims to participate when the bond market outperforms cash and protect when the bond market underperforms cash. As illustrated in Figure 1, the fund has been able to consistently deliver on its cash plus objective over time. It is this sort of consistency through various market regimes that is important when considering which funds to include in your portfolio, as you need to be confident that the fund will continue to behave as you expect into the future.

¹ Dalbar’s Quantitative Analysis of Investor Behaviour Study has been analysing investor returns since 1994 and has consistently found that the average investor earns much less than what market indices would suggest.

Figure 1: Investec Diversified Income Fund: average rolling 12-month excess returns over cash

Source: StatPro and Bloomberg. Returns are calculated on a true daily time-weighted basis net of fees. Periodic returns are geometrically linked. Data from 30 September 2010 to 30 June 2019.

• Asset manager corporate action

Change in the ownership structure, particularly where the asset manager has been acquired by a third party can be very distracting for all staff, including investment professionals, if not managed correctly. Portfolio managers and investment analysts are only human, and a change in ownership could result in an inward focus. Independent, focused asset managers with significant staff ownership are well aligned to delivering on client expectations through time.

• A better alternative emerges

While the fund selected may continue to meet its investment objective over time, it may be that a better alternative emerges. It is important then that financial advisors (and their support team / fund selection partner) continue to research the peer group. If an alternative fund consistently delivers better risk-adjusted returns, it may make sense to introduce this fund into your portfolio.

• Value for money

It is important to ensure that you are sufficiently rewarded over the long term for the fee that you pay. A lower fee may not necessarily be an indicator of a better net return outcome. On the other hand, a higher fee needs to be scrutinised to ensure that you get value for money.

• Luck rather than skill

When you made the initial investment your analysis suggested that the portfolio manager had a demonstrable skill. But over time it now appears that, for whatever reason, this outperformance proved to be because of luck not skill. A re evaluation is warranted given that luck is not enduring through time.

• Material changes to the economic and investment environment

Over time economies are expansionary and investment markets deliver positive returns, but both may become over heated. At this point it may make sense to de-risk your portfolio by reducing exposure to high beta funds (funds that follow a momentum investment philosophy, for example) and introducing more defensively-positioned funds (for example, funds that follow a quality investment philosophy). Unfortunately, timing such a move is extremely difficult and therefore it makes sense to include a defensively-managed fund to which you maintain exposure through the cycle.

While funds such as the Investec Cautious Managed, Opportunity or Global Franchise Funds meaningfully participate in strongly positive markets they demonstrate the true strength of the Quality team’s approach in sideways-moving and negative markets. The result is that they outperform through the market cycle, as illustrated in the following graph of the Investec Opportunity Fund. This enduring performance signature has benefited long-term investors.

Figure 2: Investec Opportunity Fund – relative strength in sideways to down markets

*Data since May 2000. Source: Morningstar, dates to 30 June 2019, 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.

Conclusion

While this list is not exhaustive, it provides some warning signals that should trigger the re-evaluation of your current fund holdings. Importantly, any change should be carefully considered in the context of your overall investment objectives and any potential capital gains tax consequences, which we will consider in a follow-up article. Again, we would recommend that you consult with a qualified financial advisor.

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. Issued by Investec Asset Management, September 2019.